In the run-up to the last Budget it was a truth universally acknowledged that change was coming to the tax advantages for the UK's start-up businesses. Managers and investors alike were reconciled to the fact that things would need to change, perhaps radically, if the schemes themselves were going to survive.
While initial reaction to the proposed outcomes of the Patient Capital Review was one of relief for managers who operate in the tax-advantaged investment space, the finer details of the Treasury’s plans mean that the winds of change are indeed likely to blow through the sector after all.
Since the consultation document for the Patient Capital Review was released in August 2017, rumours had proliferated that the Treasury would significantly alter the nature of both the Enterprise Investment Scheme (EIS) and make substantial changes to Venture Capital Trusts (VCTs) in parallel to a new government-seeded investment fund. Lobbying plans had sprung into action for both EIS and VCT, and entreaties to the Treasury had been made by both managers and investors.
A consensus of opinion emerged. Film and TV products would be wiped out; investments in pubs, crematoria and nurseries – whether for plants or children – would either be eliminated or curtailed; and the tax benefits for VCTs could well be reduced even if VCTs themselves might survive as an investment vehicle.
The market expected a sledgehammer, but instead the Treasury came with a scalpelThe marketing of some products as “capital preservation” and the lower-risk nature of others meant that the Treasury had taken a dim view of many products as not being sufficiently “within the spirit” of tax-advantaged benefits designed to channel capital towards high-growth British companies. As an example, MJ Hudson Allenbridge's data on the film and TV sector showed that one in five products were designed to maximise tax benefits and not investor returns, for a given level of risk, rather than building businesses.
Key points
- Rumours have proliferated following the consultation document for the Patient Capital Review.
- The sighs of relief following the consultation response were almost audible.
- Each product will now be subject to the principles-based test.
In the hours after the consultation response made it onto the Treasury’s dedicated website, sighs of relief from all concerned were almost audible. There would be no exclusion of particular sectors, no sweeping rules to outlaw asset-backing altogether and more money for investments deemed as “knowledge-intensive” enterprises.
Far from reeling under new restrictions that necessitated immediate and radical changes in strategy for managers, a principles-based approach from the Treasury meant that what might have been black and white was now shades of grey. Many managers with products thought due to be excluded suddenly realised that perhaps they could walk them back down from the executioner’s scaffold.
Managers who specialise in early-stage tech, life sciences or advanced engineering investments were quick to claim vindication, based on the release of pre-prepared declarations of victory on LinkedIn. Yet most managers who had made a living from products thought to be under threat were definitely not accepting defeat; quietly issuing statements that their strategies had been spared.
Embedded in these tweaks in the Patient Capital Review is the potential for the Treasury to accomplish what it favoured all along, but with the new rules allowing each product to be judged on its merits rather than a blanket ban on particular sectors. The market expected a sledgehammer, but instead the Treasury came with a scalpel.
Rather than specific sectors being excluded, each product will now be subject to the principles-based test to see whether they take a reasonable amount of risk to qualify for the tax advantages aimed at higher-growth and high-risk start-up companies. Investors will need to take sufficient "risk to capital" so that products are not structured to minimise their exposure and give low, stable returns, while deriving most of their returns from underlying fixed assets or contractual guarantees. If HMRC interprets these rules to eliminate such trades, while closing potential loopholes such as allowing films to claim contractual revenue on the first day of shooting, rather than the day before, investors will need to find comfort in existing higher up the risk continuum. Likewise, managers need to look to growth and not simply risk mitigation.
In combination, and allied with the higher limits for knowledge-intensive companies, these rules should accomplish the Treasury’s goal of shifting investment up the risk scale into high-potential investments, albeit at the price of possibly less diversity in the tax-advantaged market for investors to allocate to. While the jury is out on whether the Treasury will unlock all of the additional capital claimed in the Budget for higher-risk start-ups, it has succeeded in minimising investment in products considered to be blocking those with greater need.
Everyone expected a revolution from the Patient Capital Review, but the extent of it will depend on a lot of discussions about what “reasonable” means in many instances.
Simon Radford is an associate at asset management consultancy MJ Hudson Allenbridge
