Question proposed, That the clause stand part of the Bill.

With this it will be convenient to discuss the following:

That schedule 5 be the Fifth schedule to the Bill.

Clause 26 stand part.

That schedule 6 be the Sixth schedule to the Bill.

Clause 27 stand part.

These clauses and schedules will make changes to the rules for the enterprise investment scheme and venture capital trusts. I will discuss clause 27 after dealing with the rest of the group.

The changes will ensure that the schemes are brought into line with new state aid rules, which came into force in January 2015. They will ensure that the schemes continue to be well targeted towards companies that need investment to develop and grow, and they will provide for greater levels of support for innovative, knowledge-intensive companies, which play a key part in economic growth.

The UK has put forward a very strong case for schemes that go beyond the general block exemption regulations, and to support that we commissioned independent academic research into the UK equity gap. I am pleased to be able to announce that the Commission has now given its approval for the schemes. The UK is the first member state to negotiate an approval beyond the basic EU rules. That secures the long-term future of the schemes and will mean that they continue to support companies that need funding to develop and grow.

EIS and VCT have been supporting small companies to access finance for more than 20 years. The schemes provide generous tax incentives to encourage private individuals to invest in higher risk small and growing companies that would otherwise struggle to access finance from the market. The changes made by clauses 25 and 26 and schedules 5 and 6 will ensure that the  schemes are state aid compliant and that they offer support in line with the latest evidence of market failure. They will mean that additional support is provided for knowledge-intensive companies that are particularly likely to struggle to access finance.

The changes include the following provisions. Knowledge-intensive companies will need to have received their first investment through the schemes no later than 10 years after their first commercial sale, and may receive up to £20 million of tax-advantaged risk finance investment. Other qualifying companies must receive their first investment through the schemes no later than seven years after their first commercial sale, and may receive up to £12 million of tax-advantaged risk finance investment. The age limits will not apply where the investment represents more than 50% of turnover averaged over the previous five years, or where follow-on funding is being raised.

Companies will no longer be able to use money raised through EIS and VCT to acquire existing businesses, whether through asset purchase or share purchase, building on rule changes introduced in 2012 to prevent the use of EIS and VCT money to acquire other companies through a share purchase. The rules will also apply to non-qualifying VCT holdings, as well as investments by VCTs of funds raised before 2012. The employee limit for knowledge-intensive companies will be increased to 500, providing further support to innovative firms. All EIS investors will be required to be independent from the company unless the shares they already hold are founders’ shares. The requirement that 70% of seed enterprise investment scheme money must be spent before EIS or VCT funding can be raised will be removed, smoothing the interaction between the schemes. It will also be required that all investments be made with the intention to grow and develop a business.

The Government have been consulting on the majority of the rule changes since last year. A consultation was held last summer to explore how the schemes were working in practice and to gather evidence. The Government are grateful to everyone who provided evidence. Many examples were used in the state aid discussions with the European Commission. Draft legislation, based on discussions with the European Commission up to that point, was published in March for a technical consultation. A response to last summer’s consultation was published at the summer Budget. Throughout, my officials have been working closely with members of the industry and their representatives, including through a legislative working group. Many of the changes to the draft legislation first published in March, including amendments to be introduced on Report, arise from those discussions. We are grateful for the industry’s support, which it is continuing to give, including on developing the guidance in due course.

The Government will be tabling a number of amendments on Report to cover a number of areas. Most of the amendments are technical in nature and will ensure that the detailed rules work as intended, and that the new rules work correctly with the existing provisions. I would like to use this opportunity to address a point that has been raised with me by EIS and VCT investors and managers concerning the use of the schemes for replacement capital. Replacement capital is the purchase of shares from existing shareholders and is not currently allowed within the schemes. The Government are keen to provide increased flexibility when the amount  invested in newly issued shares is at least equal to the amount invested in secondary shares. The change will be introduced through secondary legislation at a later date, subject to state aid approval.

The Government are securing the long-term future of the schemes by making these changes, which will also ensure that the schemes remain well targeted and provide value for money for the taxpayer. I understand the impact that these changes will have on the way that some VCTs and EIS investors operate. Those that have specialised in investing in older, more established companies, often through management buy-outs, will be affected in particular. The Government expect that fundraising will be reduced in the 2015-16 tax year owing to the adjustment to the new rules, but also that it will recover as existing VCTs adapt and new VCTs enter the market. The Government are encouraged by recent reports from industry commentators that the industry is confident the changes can be managed and that they may help new VCTs focused on early stage businesses to enter the market.

Based on current trends, over 90% of companies seeking investment through the schemes will be unaffected by the changes to the scheme limits. Any start-up or early stage company seeking finance to grow that already meets the current rules will not be affected by the changes. Of course, EIS and VCT are only two of the many schemes that the Government provide to support small businesses. The Government also provide support through other schemes such as the angel co-investment fund, enterprise capital funds, the venture capital catalyst fund and the business growth fund to help businesses to access the finance that they need to develop and grow.

Clause 27 corrects a technical flaw that allows farming activities outside the UK to qualify for tax relief under the venture capital schemes and for enterprise management incentives. The venture capital schemes in question are the enterprise investment and seed enterprise investment schemes, and venture capital trusts. Farming activities have always been excluded from the scope of the venture capital schemes and EMI. Indeed, farming activities were excluded from the business expansion scheme that preceded the enterprise investment scheme from 1984.

Farming benefits from subsidies under the common agricultural policy. It would be unreasonable to provide extra Government subsidies under the venture capital schemes and EMI. The Income Tax Act 2007 defines farming for the purposes of the venture capital schemes and EMI in relation to activities carried out in the UK only. The provision had no effect when it was introduced. At that time, all activities under those schemes had to be carried out wholly or mainly in the UK. However, in 2010 the rules for the venture capital schemes and EMI were changed to take account of state aid rules. The changes allowed activities to be carried on outside the UK, subject to the company having a permanent establishment in the UK, but the definition of farming in the Income Tax Act 2007 was not changed to align with the new rules. The effect is that farming activities carried on outside the UK have qualified for tax relief under the venture capital schemes and EMI since 2010. That is clearly an oversight; it recently came to light and we are now correcting it.

Clause 27 will repeal a restriction on the definition of farming as an activity carried on within the UK. The restriction applies only to the venture capital schemes and EMI. The definition of farming will become the same for all income tax purposes and there will be no geographic boundaries. The effect of the change will be to stop farming activities carried on outside the UK qualifying for relief under the venture capital schemes and EMI. Farming will be an excluded activity wherever it is carried on. This was an obscure provision that interacted with the main scheme rules. In practice, only a handful of non-UK farming cases benefited from the reliefs and the costs have been negligible. Clearly it was never intended that farming should be a qualifying activity for venture capital schemes or EMI, and I hope that the clause will be a welcome correction.

The Government’s priority throughout has been to ensure the long-term future and sustainability of EIS and VCTs. The schedules make changes to ensure that they can continue to support small and growing companies to get access to the finance they need to develop and grow. The schemes will continue to be well targeted, effective and in line with state aid rules and the latest evidence on the equity gap. As I mentioned earlier, the Government will table amendments on Report to ensure the rules work smoothly, and there will be a further opportunity for debate.

I welcome the continuation of a Labour scheme from 2007 in clauses 25 and 26, and the refinement of the scheme. I congratulate the Government on securing approval from the European Commission, which has been in question for some time. That is also a replay—we will get on to this—of what happened in 2010 with farming.

I am pleased that the employee limit will be raised—to 500, I think the Minister said. That is helpful. I thank the Minister for the teaser he gave us on two occasions for the amendments to be tabled on Report, which we look forward to with excitement. I am pleased that the EIS and VCT schemes are not to be used to take over existing businesses, because that would undercut their whole raison d’être. However, in the light of that, I am a little concerned about what the Minister said about using the schemes for replacement capital. Prima facie, that is not what the schemes are intended to do, which is to kick-start and help to grow knowledge-based, innovative industries—hence the exclusion, for example, of farming. That replacement capital, of course, would keep such a business going, but in a sense it is not new money, because it is, as its title suggests, replacement capital. I am concerned about that point. We must focus on the tax relief and why it is being given.

I am pleased about clause 27. It concerns a scheme brought in by the last Labour Government—and happily continued by the coalition Government and, now, the current Government—to encourage investment in cases of market failure, and it shows that people will look for loopholes. The Minister adverted to market failure, which is also helpfully mentioned in the explanatory notes. Indeed, let me take this opportunity to pay tribute to those who compile the explanatory notes. I am sure it is a big team and they do an excellent job; the notes are very helpful. [Hon. Members: “Hear, hear!”] Would that this Government and their predecessors were a little more alert to market failure on a broader  canvas—for example, in the energy industry. That is one of the things my party is very keen on: using the levers of the state to address market failure.

This small scheme, which is being continued from the Labour scheme in 2007, is of course to do with market failure, but when it comes to farming, it shows just how cunning these tax accountants are at coming up with loopholes. As I understand it, there was no loophole for the three years before 2010. Then the European Union made a ruling on certain aspects of state aid, which meant that a company could not be wholly or mainly a UK company in terms of its operations. Lo and behold, we have a few companies—I think that the Minister’s noun was “handful”—who exploit this to carry on farming activities outside the UK, claiming tax reliefs through EIS and VCT. Had they been carrying out farming activities within the UK from the inception of the scheme in 2007, they could not have claimed that tax relief. Wow, are they cunning! They have been getting with away with it, doing something quite legitimate and lawful, as I understand it—it is avoidance, not evasion—for five years.

Of course, some aspects of farming are very knowledge-based and innovative, but that is not what these schemes are focused on, and this example underlines how vigilant we all need to be as parliamentarians about these cunning tax avoiders. The Minister and his colleagues spent years in opposition decrying my Government for an increasingly long tax code, as shadow Ministers used to call it—although that is an Americanisation, just as they pronounce leverage the American way, rather than using the proper English pronunciation. We will come to the issue of our tax legislation being so long and complicated later, but this is just one minor example of where we have to introduce anti-avoidance provisions because these experts are so cunning with their tax avoidance. I am therefore very pleased about clause 27.

I thank the hon. Gentleman for his support for these clauses. He essentially raised two points. First, he raised his concern about whether replacement capital was consistent with the rationale behind these schemes. Let me provide what I hope is some reassurance. The intention is for replacement capital to be available only where there is significant new investment in the company. That will be subject to state aid approval, but there are circumstances where it may be necessary as part of any new investment for there to be some re-organisation of capital. That is what we are getting at in this clause. Our intention is to come forward with secondary legislation on this point, and I look forward to the opportunity to debate this with the hon. Gentleman in detail when we do so.

I welcome the hon. Gentleman’s support for clause 27. It is always disappointing when a technical flaw is found in legislation, especially after a few years. It came to light only recently and we are correcting it as quickly as we can. It arises from a fairly obscure interaction between the main scheme rules and the definition elsewhere in the Taxes Act. Very few cases of farming outside the UK have received tax reliefs under the schemes.

On that point, the most information I can provide to the Committee is this. HMRC does not keep a record of tax reliefs by reference to the activities of the company.  However, HMRC’s operational staff can recall seeing no more than half a dozen or so applications a year, most of which were rejected because the company failed to meet all the requirements. The number of cases that have received relief is small, as I said earlier. Given those points of clarification, I hope the Committee is happy with these measures, and I hope they stand part of the Bill.

Question put and agreed to.

Clause 25 accordingly ordered to stand part of the Bill.

Schedule 5 agreed to.

Clause 26 ordered to stand part of the Bill.

Schedule 6 agreed to.

Clause 27 ordered to stand part of the Bill.