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For companies looking to raise funds based by a venture capital scheme and for investors looking to benefit from the tax relief, HMRC have introduced a key new condition – the risk-to-capital.
This condition is being applied to the Seed Enterprise Investment Scheme (SEIS), the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT).
The Risk-to-Capital Condition is made up of two components both of which must be met:
Under the first part of the condition, HMRC will be considering whether the company in its business plan has the clear ambition grow and develop its trade over the long term.
HMRC will look at some general indicators, such as increasing revenue, customer base and employees, together with those specific to the applicant’s business plan.
Essentially, HMRC are looking for evidence that investment is both planned to be and, in reality, is employed to support the company to grow and develop.
Under the second part of the condition, HMRC will be considering whether, at the time the investment is made, a given investment presents a significant risk of a loss of capital to the investor of an amount greater than the net return.
Essentially, HMRC will be evaluating the commercial risk of the company failing in the market.
The central issue with the Risk-to-Capital Condition is, as HMRC concedes in their internal manual, that there are no prescribed definitions of ‘growth and development’, ‘long term’ or ‘significant risk’.
As a result, this makes this a subjective decision based on interpretation. As HMRC stated on a recent webinar, “Each inspector will look at an application and view it on its merits. Each inspector obviously can interpret things in a different way……”
Venture Capital Schemes have been designed to encourage the patient capital investor. In this light, HMRC would be expecting the investor to hold their shares for longer than the three-year minimum requirement.
In addition, any indication that the future operation of the company could be compromised to enable investors to exit their investment would be seen as contrary to the objective to grow and develop in the long term.
Broadly speaking, a company that is created solely to deliver a project or a series of projects would not be considered to have objectives for long-term expansion.
This type of company, often referred to as a Special Purpose Vehicle, that would generate a certain amount of money once the project is complete, either through a steady income stream or gains on disposal of the asset created, would not be eligible for the tax reliefs under Venture Capital Schemes.
In evaluating the net investment return from a risk perspective, HMRC will include any income, such as dividends, interest payments or other fees, as well as capital growth and, potentially, the amount of upfront Income Tax relief the investors would be eligible to claim.
If the investment is in any way protected, for example by assured future income streams or capital repayment, the investment is unlikely to meet the risk condition.
However, the potential future return to an investor from the genuine growth the company expects to realise should the company be successful is not considered. As long as there is a significant risk at the time of the investment, the prospect of potential large returns in the future is not compromised by the risk condition.
It is important to remember that HMRC has the right to clawback the tax reliefs granted under Venture Capital Schemes either to the company or an individual shareholder if all the conditions are not met throughout the relevant period. In broad terms, the relevant period is three years from the investment.
As a result, it is not simply a matter of presenting a qualifying case at the time of applying for the initial tax relief, it is also about delivering on the plans and strategies through the relevant period.
If you have any questions or concerns on the Risk-to-Capital condition or Venture Capital Schemes in general, please email us at tax@cooperfaure.co.uk.
It is a win-win situation for the Company and the Investor!
The Enterprise Investment Scheme (EIS) has been made available by the government to help small to medium sized companies grow by acquiring investments. It is one of four schemes available and it provides tax relief for investors who purchase shares. Therefore, it acts as an incentive for individuals to invest into small to medium sized companies and in turn assisting the government’s goal of growth. It is a win-win situation for both parties.
If you are a company looking for investment through EIS you can raise up to £5 million per year and £12 million maximum in the company’s lifetime. There are certain legal requirements that the company must meet and these are outlined in the Income Tax Act 2007. Additionally, under the new rules the company must show evidence of long term growth and outline the high risk of potential capital loss. Overall, it is vital that the company and investors complies with the scheme’s rules for 3 years in order for the investors to receive and keep the tax relief. It is important to note that it is not solely a commitment at the point of investment but must be adhered by for 3 years.
HMRC enables companies to apply for Advanced Assurance before shares are issued. This can aid the company to receive investment as it provides investors with assurance whether the company will be eligible for EIS. Please note that HMRC no longer provide advanced assurance on applications entailing speculative investors. Therefore, potential investors must be detailed in the application and the process cannot be commenced without the company having an idea of whom their investors will be.
We at CooperFaure can assist in compiling all of the following which is required for an Advanced Assurance Application:
If the company is not going to apply for Advanced Assurance the full list stated above is required to be submitted alongside the Compliance Statement (EIS1 form). Once it has been reviewed by HMRC’s Small Companies Enterprise Centre (SCEC) it will either be refused or approved. If the Compliance Statement is approved SCEC will send the company two forms EIS2 and EIS3. EIS2 states that the company is authorised to issue certificates that they are a qualifying company. EIS3 are blank forms that the company is required to fill in and send to the individual investors as a certificate. These certificates enable the investors to receive tax relief. Without proof of EIS3 the investor will not be able to claim tax relief.
A company must not submit the Compliance Statement until at least 4 months of the specific trade or research and development has been carried out for which the money is raised. Additionally, it has to be submitted before 2 years has passed from the end of the specific tax year that the shares were issued or two years after the end of the period of four months referred to above.
In order for the investor to make a claim they need to have an EIS3 certificate as stated above, ensure that they meet all of the conditions and that the claim is made within 5 years after the 31 January following the tax year in which the shares were issued.
The investor cannot have any connection with the company in order to qualify for tax relief. The following are examples of people who will not qualify due to this reason:
All of the conditions above apply for 5 years and this period is for 2 years before and 3 years after the latest of date the shares were issued or date of start of trade.
Additionally, as well as the examples provided above the 30% rules apply for an associate and therefore will not qualify as an investor. An associate can be anyone of the following:
For shares distributed at incorporation and before trade has commenced or more shares are issued the 30% rule does not apply.
Siblings are not seen as associates of the company and can therefore qualify as an investor as long as all the other conditions mentioned above are met.
If the investor receives any value for example in terms of a loan or shares are repurchased during the 5-year period the relief received from EIS must be withdrawn or reduced.
For further details how to take your business to the next level please read our previous newsletter.
We at CooperFaure believe that EIS is a great scheme for most companies to attract investors in order to grow their company. We have assisted numerous clients with the EIS process and have found that as long as all the information is correctly provided to SCEC and all conditions are met there is no reason for the company not to be eligible for EIS.
If you would like to arrange an initial consultation that is free and without obligation to discuss your circumstances, please email us at tax@cooperfaure.co.uk.
Answer our 6 simple questions to help you establish if your company is eligible for R&D Tax Relief:
Please click here for the questions.
If you would like to arrange an initial consultation that is free and without obligation to discuss your circumstances, please email us at tax@cooperfaure.co.uk.
The HMRC is part way through a major consultation on the reform of off-payroll working, aka IR35, in the private sector which ends on 10th August.
Their premise is that two people undertaking the same work, one employed and one working as a contractor working through their own Personal Service Company, end up “paying very different levels of tax” which HMRC deem to be unfair. As a result, HMRC are considering rolling out the reforms introduced in 2017 to off-payroll working in the public sector to the private sector.
Their main illustration in the consultation document available here compares the level of tax paid by Charlie, a contractor working through his own company, and Thomas, an employee. If anything, the illustration overstates the amount of tax that Charlie would pay. Any accountant or tax advisor worth their salt would ensure that less is paid.
The over-arching undercurrent of the consultation is that the actions of contractors using a Personal Service Company is borderline tax avoidance and, as such, against the public interest.
It is hardly breaking news, but a contractor earning the same as an employee will pay less tax!
On the other hand, the consultation ignores that the contractor usually has a minimal notice period and has waived employee entitlements and benefits such as holiday pay, sick pay, workplace pension auto-enrolment and the right to bring a claim for unfair dismissal.
Moreover, maybe understandably, the consultation is blinkered on tax. The HMRC estimates that “the cost of non-compliance in the private sector is high and growing – projected to increase from £700 million in 2017/18 to £1.2 billion in 2022/23.”
Personal Service Companies are not elaborate tax structures funnelling vast sums of money offshore. These are small businesses and, if we accept the HMRC estimates, whilst these monies are not going to the Exchequer, they are being spent in the UK economy.
However, the biggest flaw in the consultation is that the private sector is not the public sector. The public sector is predominantly made up of monolithic organisations with hefty headcounts. The private sector is a broad canvas from the FTSE 100 to a start-up working from home.
Here lies the real danger. As Brexit approaches and the government is channelling its energies through the Department for International Trade to make the UK a centre for innovation, this reform would be a death knell for start-up and early stage businesses.
Whilst the UK offers some fantastic incentives for innovation, these are largely after the fact. The R&D Tax Credit will provide a much-needed cashflow stimulus but, for a start-up today, only in fifteen months’ time.
At CooperFaure, we are working with an array of start-up and early-stage businesses across a wide range of sectors and they all engage contractors.
There is no doubt under the myopic vision of the HMRC consultation, these contractors would be deemed to be employees. However, there is a bigger picture.
For a start-up, cash management is one of the cornerstones for success and engaging a contractor is a less expensive and more flexible option. Not to mention, less administratively burdensome.
The rationale is not to avoid tax rather to provide a stepping stone to a more mature business. We can site numerous cases where a start-up has evolved through the use of contractors and is now employing a substantial workforce.
As with any consultation, it is vital to make your voice heard. Not just the voice of the contractor but also the voice of the entrepreneur and business owner.
The official channels to respond to the consultation are by email to offpayrollworking.intheprivatesectorconsultation@hmrc.gsi.gov.uk or by post to IPD Employment Status and Intermediaries Policy, Room 3/46, 100 Parliament Street, London, SW1A 2BQ.
However, you should also consider writing to your MP, the details for which can be found here, or to the Chancellor directly at HM Treasury, Horse Guards Road, London, SW1A 2HQ.
In the meantime, if you have any questions or concerns, please email us at tax@cooperfaure.co.uk.