VCTs face dramatic overhaul due to new limits

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VCTs face dramatic overhaul due to new limits

No Budget is complete without some new meddling with the rules around tax-advantaged venture capital schemes buried in the notes and this Budget was no different.

In March 2015, the Budget contained proposals to tightened the rules around eligible investments for VCTs and EIS primarily to ensure they complied with European State Aid rules. At the time HMRC set out a proposal to introduce a restriction on the age of a business that had not previously existed (to 12 years and 10 for “knowledge intensive companies”) and a new lifetime allowance for the overall level of tax advantaged funding that could be received of £15m.

Today sees the proposed company “age limit” drastically scaled back further with investment now to be directed to companies within seven years of their first commercial sale (10 in the case of “knowledge intensive” companies), clearly directing VCTs towards much earlier-phase businesses.

Current VCTs have backed companies that were first set up decades ago, but have helped them, often under new management, grow significantly.

Aditionally, the lifetime limit for tax advantaged funding has been carved back from £15m in March to £12m as of today’s announcement (£20m for “knowledge intensive” companies), an adjustment that might partially reflect exchange rate changes, since these rules are being driven by Europe.

In a subsidiary paper issued today, HM Treasury have also confirmed that existing VCTs will no longer be able to reinvest monies raised from exits in businesses that were previously eligible at the time of funding (such as MBO backed deals) into similar transactions.

Therefore grandfathering of previous deal types looks set to end and therefore proceeds for exists will either need to be reinvested in companies meeting the new restrictions, or returned to shareholders as special dividends.

Additionally, there is a new proposal introducing greater restrictions on how monies are invested within a VCT’s non-qualifying portfolio, preventing for example support for MBOs.

In my view these are probematic changes, which will over time see VCTs refocus on earlier-phase businesses and inherently limit the range of investment opportunities.

That isn’t great news for long established, small companies with the scope to create jobs and wealth, who still need access to capital but will no longer be eligible for this form of financing because of greater restrictions. The age of company in itself has no relevance to a businesses funding needs or its scope for fuelling economic growth.

We were already expecting many VCTs to seek much lower levels of new fund raising this tax year as a result of the previously proposed restrictions and, it should be noted, VCTs managed by leading group NVM recently chosen to return existing capital to shareholders citing a lack of opportunities and highlighting EC meddling as a concern.

Potentially lower fund raising activity due to a narrower set of investment opportunities ironically comes at a time when potential demand for VCTs from investors might otherwise have been stronger than ever as a result of the reductions in the lifetime pension allowance and the tapering away of pension tax allowances for higher earners, confirmed in the Budget today.

Jason Hollands, managing director, business development and communications, Tilney Bestinvest

The Changes - in detail

2.71 Venture capital schemes: changes to scheme rules – The government will, subject to state aid approval, and with effect from Royal Assent to the Summer Finance Bill 2015:

• Require that all investments are made with the intention to grow and develop a business.

• Require that all investors are ‘independent’ from the company at the time of the first share issue.

• Introduce new qualifying criteria to limit relief to investment in companies that meet certain conditions demonstrating that they are ‘knowledge intensive’ companies within 10 years of their first commercial sale, and other qualifying companies within seven years of their first commercial sale; this will not apply where the investment represents more than 50% of turnover averaged over the preceding 5 years.

• Introduce a cap on the total investment a company may receive through the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) of £20m for knowledge- intensive companies, and £12m for other qualifying companies.

• Increase the employee limit for knowledge intensive companies to 500 employees.

• Introduce new rules to prevent EIS and VCT funds being used to acquire existing businesses, including extending the prohibition on management buyouts and share acquisitions to VCT non-qualifying holdings and VCT funds raised pre-2012, and preventing money raised through EIS and VCT from being used to make acquisitions of existing business regardless of whether it is through share purchase or asset purchase. (Summer Finance Bill 2015).

2.72 Venture capital schemes: changes to scheme rules – The government will remove the requirement that 70% of Seed Enterprise Investment Scheme (SEIS) money must be spent before EIS or VCT funding can be raised for qualifying investments made on or after 6 April 2015. (Summer Finance Bill 2015).