HMRC Assesses VC Schemes

by Robin Pilgrim, LawAndTax-News.com, London

06 April 2010

The UK government has produced an evaluation of its Venture Capital Schemes, the Enterprise Investment Scheme (EIS), Venture Capital Trusts (VCTs) and Enterprise Management Incentives (EMI), which give tax relief to investors in small companies, to ensure the schemes comply with the European State Aid Risk Capital guidelines and fundamental European Union treaty freedoms.

The EIS and VCT schemes aim to improve small higher risk trading companies’ ability to secure longer-term financial support in the form of equity investments. They do this by offering investors income, capital gains and corporation tax reliefs in return for investing in small companies undertaking an activity that qualifies under either scheme.

EMIs are tax advantaged employee share schemes, under which companies can offer their employees share options with income tax and National Insurance contribution advantages. EMIs are designed to help smaller companies, particularly in the riskier areas of the economy, to recruit and retain the staff they need to grow.

The EIS has raised almost GBP6.3bn, which has been invested in around 14,500 small companies. VCTs have raised GBP3.5bn and invested in over 1,500 small companies.

The schemes were notified to the European Commission as state aids in May 2007. They received approval in 2009, subject to a number of changes being made to ensure that the rules governing the schemes comply with EU state aid rules.

Small companies eligible under the schemes are defined as having gross assets not exceeding GBP7m before the share issue and GBP8m after; employment must be less than 50 full-time equivalent employees when shares are issued. There are also rules to ensure companies are independent and trading. Certain activities are excluded from the schemes in order to target higher risk trades more in need of support.

According to HMRC, companies already benefiting from investments under the schemes will be allowed to take greater advantage of the international opportunities to expand. In the same vein, the UK government also intends to allow VCTs to list elsewhere in Europe, should that make most commercial sense.

In order to comply with EU conditions the UK government intends to amend the scheme rules as follows:

• Companies qualifying to receive investments under the schemes are currently required to carry out their qualifying activities “wholly or mainly“ in the UK as are companies benefiting from EMIs. The requirement is interpreted as meaning that more than 50% of the qualifying activities should be in the UK. It is now intended to relax this rule to simply require any company receiving investments under the tax-based venture capital schemes to have a permanent establishment in the UK. The definition used will be based upon that contained in Article 5 of the OECD Model Tax Convention on Income and on Capital (2003);
• There is also currently a requirement for VCTs that "the shares making up the company's ordinary share capital...have been or will be included in the official UK list throughout the relevant period". It is now proposed to relax this rule. Instead, the shares making up the company’s ordinary share capital will be required to be admitted to trading on a European Union Regulated Market. A "European Union Regulated Market" is any regulated market named under the Markets in Financial Instruments Directive (MiFID). This option also responds to calls from small business and the venture capital sector to make the schemes more flexible;
• It is proposed to introduce a rule excluding companies that are “in difficulty” according to the criteria set out in the Commission’s guidelines on state aid for rescue and restructuring from the benefit of the venture capital schemes; and
• VCTs are currently obliged to onward invest a minimum of 70% of their total fund in ‘qualifying holdings’. Of that 70%, a minimum of 30% (i.e. 21% of the total fund) must be in ‘eligible shares’, which the Commission accepts constitutes ‘equity’ according to the definitions in the State Aid Risk Capital guidelines. However, these EU guidelines require that 70% of qualifying holdings be invested in ‘equity’ or ‘quasi-equity’. Accordingly a minimum of 70% of VCTs’ qualifying holdings (i.e. 49% of the total fund) will be required in a form that the Commission would accept as ‘equity’ or ‘quasi-equity’.

Legislative changes in the Finance Bill 2010 will give effect to these amendments. According to HMRC, any significant impact on VCT fundraising will be seen by 2011. EIS will take several years, the department said, because of the long time lags for company returns as will EMI, due to time lags between grant and exercise of share options.

Recommended