Navigating the Budget changes

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Navigating the Budget changes

Investors in Enterprise Investment Schemes (EIS) were expecting some changes to be announced by chancellor Philip Hammond in the Autumn Budget.

A year earlier, in November 2016, the government launched its Patient Capital Review with the aim to consider “how to support innovative firms to access the finance that they need to scale up”, according to gov.uk.

The outcome of this consultation was due on the same day as the Budget, so expectations were high as to the extent of the reforms Mr Hammond might unveil.

Among the changes as detailed in the consultation response paper were:

  • Establishing a new £2.5bn Investment Fund incubated in the British Business Bank with the intention to float or sell once it has established a sufficient track record. By co-investing with the private sector, a total of £7.5bn of investment will be supported.
  • Significantly expanding the support that innovative knowledge-intensive companies can receive through the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) while introducing a test to reduce the scope for and redirect low-risk investment, together unlocking over £7bn of new investment in high-growth firms through EIS and VCTs. 
  • Investing in a series of private sector fund of funds of scale. The British Business Bank will seed the first wave of investment with up to £500m, unlocking double its investment in private capital. Up to three waves will be launched, attracting a total of up to a total of £4bn of investment. 

The chancellor was also rather pleased to announce in his Budget speech a doubling of the EIS annual investment allowance, from £1m to £2m, although he confirmed any amount above £1m should be invested in “knowledge intensive” companies.

Further details on companies which fall into the definition of being knowledge intensive can be found here.

Tackling the challenge

Dr Ilian Iliev, chief executive at EcoMachines Ventures, explains: “As expected, HM Treasury is starting a pushback against the use of EIS scheme for capital-preservation/asset backed investment. 

“Instead, the focus is firmly on using the EIS scheme to support/encourage investments into knowledge-intensive companies.”

He goes on: “That looks like a direct response to the UK’s 'scale-up' challenge - the finding that there are simply not enough funds for Series A and B investments into knowledge intensive companies going from first revenues to scale-up/growth. So this is very welcome indeed.”

He predicts this may lead to increased use of EIS funding for Series A or early B funding for growth companies, which he notes is much less risky than seed investment, but where the capital needs are greater.

In a world where we will need to attract and trade internationally we should continue to incentivise high risk activities that support and grow this centre. Phil Cook

John Glencross, chief executive of EIS and VCT manager Calculus Capital, insists: “The increase to EIS investment limits – for end investors and for certain companies receiving funding – demonstrate the government is investing in the UK’s enterprise sector and is backing EIS as an important vehicle for making that investment. 

“This is great news for investors and the growing businesses that will benefit from their investment.”

Sensible direction

The scope of the changes was a relief for many in the industry, who had predicted the Patient Capital Review might publish more stringent conclusions.

Mark Brownridge, director general of the EIS Association, acknowledges: “The EIS Association and its members put a great deal of work into making detailed representations to HM Treasury in the run-up to this budget. 

“We did so because there had been suggestions that wide-ranging changes to EIS were under serious consideration. We are therefore extremely pleased to see that no changes to EIS tax reliefs or holding periods will be introduced, nor will there be any new exclusions for certain sectors.”

He added: “We understand that within a consultation paper to be made available very soon, a principles-based approach to assessing whether companies applying for EIS funding eligibility are genuine ‘risk’ investments, using a ‘reasonable person’ test, will be introduced. 

“Pending sight of the detail in the document, we see this as a sensible way forward for ensuring that EIS investment is only directed at genuine, entrepreneurial, growth businesses.”

Whether doubling of the EIS allowance for knowledge intensive companies will help raise further capital is questionable as most investments in EIS are relatively small.Phil Cook

There had been concerns one of the conclusions to come out of the Patient Capital Review would be to make industries, such as media, ineligible for inclusion in EIS.

As Phil Cook, private client partner at Thomas Miller Investments notes: “The significant presence in high skill industries that the UK has built up over the last 20 years, since Gordon Brown started to encourage media projects in this country, is a big tax earner for the Treasury.

"Therefore we are pleased to see that media will still be eligible for EIS status, even if some of the pre-contracted arrangements will no longer qualify.  

“London is a global media hub and in a world where we will need to attract and trade internationally we should continue to incentivise high risk activities that support and grow this centre.”

But he too queries: “Whether doubling of the EIS allowance for knowledge intensive companies will help raise further capital is questionable as most investments in EIS are relatively small and individuals, with deeper pockets, may already invest £2m using carry back to a previous tax year. 

“Only time will tell if this measure actually leads to further investment.”

Subject to change

This is not the first time EIS has been through some change. Mr Brownridge recalls there have been various reforms over the years.

“The most recent, in 2015, have meant investment is more closely targeted at smaller and younger companies, as well as those considered to be ‘knowledge intensive’, which is to say those with higher research and development costs developing ‘innovative’ products and services,” he notes.

“An earlier change excluded businesses generating energy from investment under the scheme.

“Such changes have been made to help ensure that the generous tax reliefs provided by EIS are being used to help those businesses that have the greatest potential to help the UK economy move forward and grow.”

Hugi Clarke, director at Foresight Group, acknowledges: "Taken together, these changes have led EIS managers to focus on younger, less developed businesses offering less predictable returns, but the potential for greater upside."

What advisers should do

Do the latest set of changes mean EIS is no longer suitable for some investors?

Jack Rose, head of tax-efficient investments at LGBR Capital, replies: “In terms of suitability, that will need to be judged on an individual’s personal circumstance and the specific product in question. VCTs and EIS are, and will remain, higher risk investments."

He confirms: “They are not suitable for everyone and that will continue to be the case. It is up to individual product providers to explain the impact of these changes on their products to their clients so they can make a judgement to any changes in the risk profile for their recommendations to clients.”

Mr Brownridge suggests advisers should do their research on the funds and satisfy themselves they are suitable for their clients.

Simon Ruthers, director, business development at Oxford Capital, says the new rules mean advisers need to change how they think about EIS.

"EIS planning has now become a year-round exercise with advisers needing to take advantage of EIS opportunities as they arise, rather than leaving it to the last minute," he explains.

“Advisers should consider phasing their clients’ investments into EIS opportunities as they arise and think more about asset allocation and portfolio construction if they are to deliver the right outcome.”

eleanor.duncan@ft.com