As you may be aware, there has recently been some discussion around proposed changes to EIS and SEIS tax incentives for investments in smaller companies. In particular with regard to the new rule called ‘The Risk To Capital Requirement’. This has been of particular interest to the film and TV industry but will also be of relevance to other sectors, particularly any business requiring the ownership of valuable assets (e.g. premises).
This rule will be introduced in respect of investments made after Royal Assent of the Finance Bill, which is anticipated to be in March 2018. However, going forward, HMRC will not give any Advance Assurance Opinions for EIS and SEIS companies without taking this requirement in to consideration. So, in reality, any Advance Assurance applications from now on will need to address this criterion.
In another announcement, HMRC have stated that from 2 January 2018 they will no longer provide an Advance Assurance where the application fails to name the individuals / fund managers or other promoters who are expected to make this investment. At the time of writing, HMRC have not officially clarified this point in their guidance. It is unlikely that many EISs or SEISs will be potentially fully funded before applying for Advance Assurance so some clarification from HMRC as to what, and how much, evidence will suffice is required is eagerly awaited. Nevertheless, it is understood that HMRC will accept an outline of potential means of getting finance which may indicate, for example, potentially using something like a crowd funding platform or a list of target investors. It is not expected that any list would need to cover the whole amount of the raise at this stage.
The new rule; Risk To Capital Requirement
This new rule stems from the so-called Patient Capital Review Consultation which, inter alia, sought to address concerns that certain EIS/SEIS/VCT offers were asset backed and involved little risk to the investor. The approach taken by the Treasury and HMRC is to have a fluid test which allows some flexibility. This means taking a reasonable, overall, view and, in theory, only those close to the margins and pushing the boundaries should be concerned. Nevertheless, we are all aware that attitudes and interpretations can change over time and that if, inadvertently and innocently, one does have a situation close to the margin, there is a risk that HMRC’s view does not give the desired outcome and there is no appeal process, nor is one being considered.
So, what is the new rule? Basically it is now a requirement that the company can demonstrate an objective of growing and developing in the long term and that the investor is taking a significant risk. There are no precise definitions of ‘Growth and Development’ nor ‘Long Term’ but single projects are very unlikely to work, even a finite small slate of projects would be likely to fail too. As for risk, the amount that the investor puts at risk of loss, must exceed all net returns that are likely at the time of making the investment. Presumably the word ‘likely’ suggests that there is some degree of certainty through arrangements either in place or in discussion, although this is not entirely clear at this stage. It is anticipated that further clarification on this issue will be incorporated into the final guidance due to be published in April 2018.
It is suggested that future Advance Assurance applications for EIS and SEIS should include financial forecasts going on beyond 3 years, identifying how turnover, projects, activities, employees etc. will increase. Furthermore, the application should make it clear that the company is going to be managed and run by genuine entrepreneurs with long term ambition and certainly not operated by some sort of investment institution.
Meanwhile it is encouraging that EIS limits have doubled for investments in Knowledge Intensive Companies (KIC). A KIC is, broadly, a company that spends in the region of 10% / 15% of its operating costs on research and development, innovates IP and / or has skilled full time staff.