EIS, SEIS and VCT reliefs: risk to capital

Finance (No. 2) Bill – in a Public Bill Committee at 2:30 pm on 9 January 2018.

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

With this it will be convenient to discuss the following:

Clause 15 stand part.

Clause 16 stand part.

That schedule 4 be the Fourth schedule to the Bill.

Clause 17 stand part.

Government amendment 1.

That schedule 5 be the Fifth schedule to the Bill.

New clause 6—Review of risk to capital changes—

‘(1) Within fifteen months after the first exercise of the power to make regulations under section 14(4), the Chancellor of the Exchequer must review the effects of the changes made by section 14.

(2) The review under this section must consider—

(a) the revenue effects of the changes, and

(b) the effects on the long-term growth and development of companies.

(3) The Chancellor of the Exchequer must lay before the House of Commons the report of the review under this section as soon as practicable after its completion.’

This new clause provides for a post-implementation review of the changes in Clause 14.

New clause 7—Review of changes to EIS and VCT reliefs for knowledge-intensive companies—

‘(1) Within fifteen months after the first exercise of the power to make regulations under paragraph 10 of Schedule 4, the Chancellor of the Exchequer must review the effects of the changes made by that Schedule.

(2) The review under this section must consider—

(a) the revenue effects of the changes, and

(b) the effects on the policy objective to facilitate and encourage additional investment in innovative companies developing and exploiting new technologies.

(3) The Chancellor of the Exchequer must lay before the House of Commons the report of the review under this section as soon as practicable after its completion.’

This new clause provides for a post-implementation review of the changes in Schedule 4.

New clause 8—EIS, SEIS, SI and VCT reliefs: review of operation—

‘(1) Within twelve months after the passing of this Act, the Chancellor of the Exchequer must review the operation of the reliefs established under Parts 5, 5A, 5B and 6 of ITA 2007.

(2) The review under this section must consider—

(a) the revenue effects of the reliefs and changes made to those reliefs since the passing of the Finance Act 2012,

(b) the employment effects of the reliefs and those changes,

(c) other economic effects of the reliefs and those changes, and

(d) the extent to which trusts or other entities have been created to secure benefits from the reliefs and those changes without providing wider employment or economic benefits.

(3) The Chancellor of the Exchequer must lay before the House of Commons the report of the review under this section as soon as practicable after its completion.’

This new clause provides for a review of the operation of the enterprise investment scheme, the seed enterprise investment scheme, income tax relief for social investments and venture capital trusts income tax relief.

Photo of Mel Stride Mel Stride Financial Secretary to the Treasury and Paymaster General

Clauses 14 to 17 and schedules 4 and 5 make changes to the tax-advantaged venture capital schemes as part of the Government’s response to the patient capital review. They also correct minor technical flaws in the legislation, to ensure that the legislation works as intended. The changes aim to drive more than £7 billion in new and redirected investment into high-growth companies over the next 10 years.

Responses to the patient capital review consultation pointed to the continuing importance of these schemes in incentivising investment in early-stage companies that would otherwise struggle to receive investment to help them grow and develop. However, evidence provided during the consultation, backed up by Sir Damon Buffini’s industry panel, suggested that knowledge-intensive companies, which are particularly research and development-intensive, still struggle with some of the most acute funding gaps, despite their growth potential. This is because they often require a large amount of capital up front to fund their growth, and it can be many years before their products can be brought to market. Evidence provided through the consultation also highlighted a large subset of low-risk capital preservation investments structured around the tax reliefs. One response showed that £467 million of funds raised by enterprise investment scheme funds in 2016-17 were aimed at schemes that could be described as capital preservation.

Clause 14 introduces a new “risk to capital” condition for the enterprise investment scheme, the seed enterprise investment scheme and venture capital trusts, in response to evidence of continuing capital preservation investments using the venture capital schemes. The condition takes a principles-based approach to deny tax relief to these investments. Investments will be excluded where it is reasonable to conclude that the company does not have the objective of growing and developing its trade in the long term and there is no significant risk that any loss of capital will be greater than the net return on the investment. The measure would take effect from Royal Assent.

Clause 15 makes technical changes to ensure that the rules on determining the amount of funding a company may receive in its lifetime, under the EIS, VCTs or social investment tax relief, work as intended. The clause ends certain transitional provisions introduced in 2007 and 2012, which excluded certain investments from counting towards the lifetime limit, and ensures all risk finance investments are counted towards the lifetime funding limits for the EIS, VCT and SITR schemes. This will apply to new investments on or after 1 December 2017.

Clause 16 and schedule 4 make three changes in response to the patient capital review. The changes will significantly expand the support offered to knowledge-intensive companies through the EIS and VCTs. The annual limit on how much an investor can invest through the enterprise investment scheme will be raised from £1 million to £2 million. Any investment over £1 million must be invested in knowledge-intensive companies.

Knowledge-intensive companies often need large funding rounds as they are highly capital-intensive. With this in mind, we are doubling the annual investment limit for knowledge-intensive companies using the EIS and VCT schemes to £10 million. Under the current EIS and VCT rules, knowledge-intensive companies must be broadly under 10 years of age when receiving their first qualifying investment. The clock starts when the company makes its first commercial sale. Knowledge-intensive companies sometimes find this point difficult to identify. Clause 16 introduces flexibility to this rule by allowing knowledge-intensive companies to choose to start the clock at the point they reach an annual turnover of £200,000.

Before I turn to Government amendment 1 to schedule 5, I will give some background, if I may, to introduce clause 17 and the schedule. Clause 17 and schedule 5 make changes to the VCT rules. Schedule 5 corrects a technical flaw and changes some of the rules to encourage VCTs to invest more of their funds in qualifying growth companies and to invest those funds more quickly. Government amendment 1 introduces new rules on qualifying loans to encourage VCTs to make longer-term investments in higher-risk companies. Some VCTs have used loan structures as a method of capital preservation, charging prohibitively high interest rates and including other conditions in the terms of the loan. The effect is to secure a return of capital well before the end of the five-year minimum period. Amendment 1 is intended to prevent the use of low-risk loans to minimise risk to the VCT and to its investors, including where the terms involve very high interest rates, redemption premiums and other charges. I commend Government amendment 1 to the Committee.

I turn to the rest of the provisions in schedule 5. The schedule corrects a flaw in an anti-abuse rule introduced in 2014 to prevent investors from being punished for mergers they did not know were about to occur. The changes will apply retrospectively, from the introduction of the anti-abuse rules in April 2014. The proportion of VCT funds that must be invested in qualifying companies will be raised from 70% to 80%. This will ensure that a greater proportion of VCT funds reaches the target companies. Once a VCT realises a gain by disposing of an investment, it must reinvest that gain within six months. Many VCTs currently pay out the proceeds as a dividend instead. To encourage more reinvestment by VCTs, schedule 5 raises the reinvestment period to 12 months. These last two changes take effect from April 2019 to allow VCTs time to adjust their investment portfolio.

VCTs currently have up to three years to invest funds after those funds are raised. A new rule will require them to invest at least 30% of funds in qualifying companies within one year of the end of the accounting period in which they were raised. This will accelerate investment of money raised from investors and will apply to funds raised from 6 April 2018.

Many previous changes to the VCT rules have been grandfathered. This means new investments can still be made under the old rules that applied when the money was originally raised. These transitional provisions enable some VCTs and their investors to access a range of generous tax reliefs on low-risk investments. The schedule will ensure that all VCT investments meet the current rules, regardless of when the original money was secured. These changes will take effect for investments from 6 April 2018.

New clauses 6 to 8 call for reviews into some of the changes made in this legislation, as well as a review of the efficacy of the venture capital schemes as a whole, but the changes made in the legislation are the result of a thorough review of all the venture capital schemes as part of the patient capital review. The review concluded that the schemes did vital work in providing capital for high-growth companies but that certain changes would make the schemes more effective and fairer for the taxpayer. Because we are committed to making the schemes work better, the Government have already committed to a report on the changes. An initial report to the Chancellor of the Exchequer for Budget 2018 will set out how the different measures in the Government response are being implemented. Then, in autumn 2020, a report will assess the impact of the policies set out in the Government response, including the clauses in this Finance Bill.

A review of this condition any earlier than 2020 would not be able to make any reasonable assessment of the effect of the changes on the scheme. It would be working from a single year’s data on the impact on Government revenue and would be unable to assess the impact on the long-term growth and development of businesses. In the meantime, HMRC publishes statistics on the use of venture capital schemes every year. The information includes details of amounts invested and company activities. The first figures reflecting the effect of the new changes for the tax year 2018-19 will be available in April 2020. These will be closely monitored. I therefore urge the Committee to reject the new clauses.

Sir Roger, these changes significantly expand the venture capital scheme’s innovative, knowledge-intensive companies while reducing the scope for low-risk investment within them. They will drive more than £7 billion of investment towards high-growth companies over the next 10 years and ensure the smooth operation of these important schemes. I therefore commend clauses 14 to 17 and schedules 4 and 5 to the Committee.

Photo of Peter Dowd Peter Dowd Shadow Chief Secretary to the Treasury

I will speak to our amendments to schedule 4, which also affect clauses 14, 15, 16 and 17.

May I start by telling the hon. Member for Middlesbrough South and East Cleveland, who was slightly confused as to which way he should vote, I am not sure whether if I had a spoken a little less he might have come our way, or perhaps he would have done so if I had spoken a little longer. We will never know, alas.

Clause 14 seeks to amend the requirements for investment to qualify for relief under the enterprise investment scheme, seed enterprise investment scheme or the venture capital trust scheme. As indicated, it also introduces an overarching risk-to-capital condition to deter investment companies whose activities are mostly geared towards protecting capital through minimising risk rather than supporting long-term growth and development of UK enterprise. It is important to start with that proposition.

Clause 14 also introduces a new principle-based risk-to-capital test that would change the current regime in which HMRC provides assurances for investments in advance. In the not too distant future, I am also going to introduce the T word—the transparency factor— I am giving notice of that.

Under this measure, HMRC would no longer provide advance assurance for investments that would appear not to meet the terms of the new rule. The Treasury has stated that if the new test proves effective in simplifying the conditions, this approach may be used to simplify further aspects of venture capital schemes legislation. It is clear that the current legislation is a maze of complexity that makes it difficult for businesses and advisers to establish that qualifying conditions are met with certainty, and also for HMRC to ensure that the reliefs are being used correctly and are not subject to abuse.

The current complexity creates a scenario whereby cash-strapped start-up companies have to use their limited funds to purchase professional advice on how to access the relief. The Chartered Institute of Taxation, for example, has argued that this creates a conundrum, where ultimately the success of the start-up and its ability to access these funds is simply down to whether it can afford professional advice.

The new principle-based risk-to-capital test will mean that start-up companies are largely dependent on the guidance issued directly by HMRC on its website. This guidance will be wholly dependent on whether HMRC decides to update the website. It may also be contingent on the fact that HMRC has seen funding and staffing levels cut consistently in the past few years. I have referred to my own constituency as a victim of that practice. I think those cuts will continue. This is why the advance assurance service currently in use is under pressure and it appears that the Treasury is seeking to pursue a cheaper option that will ultimately require fewer staff and, importantly, result in a lower-quality service.

The very people the relief is intended to help struggle to access it. The changes outlined will only make it harder. In my experience, and I suspect the experience of many members of the Committee, very few start-ups can afford the expensive and technical financial advice that will be needed to access this cash. Therefore, it is more likely to be taken up by companies that are established and may be in less need of the relief.

That poses a particular concern for tax accountants who will have to interpret the guidance on the HMRC website and make a judgment call as to whether the client is entitled to the relief. The withdrawal of the advance assurance service in relation to the new test has the potential to undermine certainty and practicability for these tax advisers, unless there is detailed guidance from HMRC that provides real-life examples. There appears to be a lack of confidence among professional bodies representing tax accountants on the reliability of HMRC in issuing this guidance. There is a fear that investors and accountants could contravene the conditions for the relief and have to pay expensive penalties.

Those conditions lead to the wider question that underpins new clauses 7 and 8 on the operation of the reliefs. As we were told by the Chancellor in the Budget, the UK’s public finances are in a precarious place. Our finances are so limited that we must expect a further decade of belt tightening and more cuts to public services. With that economic background in mind—low growth, all the stuff we have discussed before, and so on—it is only right for the Opposition to ask the Government to provide a review of the operation of these reliefs and their effectiveness against the stated aims.

The Minister talks about 12 or 19 months not being an appropriate period of time. The problem with that is that if we had said two, three or four years, I suspect the Government would still have declined our generous offer for a review, but there we are. The Minister may not have the figures to hand—he often does, I must say—but I would like to try to establish how many individuals have benefited from the EIS, SEIS, SI and VCT reliefs since their introduction; the value of these reliefs in terms of the tax breaks given; and in what sectors these reliefs have been made, as well as any economic assessment of their impact on the economy. To be fair, I think the Minister touched on some figures.

New clause 8 raises those questions, which go to a deeper question of tax transparency for the Government. The Government have been handing out millions of pounds each year in tax breaks and what has become known as corporate welfare to private companies, wealth corporations and wealthy investors who operate in the UK economy yet refuse to publish a clear list of where that money has gone, to whom it has been given and its direct impact on the economy. That is particularly important, given the fact that some of these investors will take their profits and put them offshore. It is a strange set of circumstances where the ordinary taxpayer is held to a higher level of transparency through the disclosure of huge amounts of detail to HMRC than wealthy investors who are able to gain large tax reliefs through investing in venture capital trusts.

New clause 7 seeks a review of changes to EIS and VCT reliefs for knowledge-intensive companies. That review would require the Minister to report to Parliament on whether those tax reliefs have been effective in encouraging more investment in innovative companies that exploit new technologies which have ultimate benefit for the UK economy—and, importantly, for UK taxpayers and workers. As the Opposition made clear in our response to the Budget, we do not believe that these measures alone represent anything near the level of investment we are going to need if we are to revitalise the economy, and trickle-down economics is not working. The Government have argued that tax cuts and tax reliefs will somehow generate growth and wealth for all; yet living standards continue to fall. Some 7.4 million people in working households live in poverty; they work harder and longer, on lower wages, and have little money of their own to invest, yet they will not receive such a generous tax break from the Government. It is imperative that their tax money is used responsibly and that there is transparency over who benefits from these reliefs and what effect, if any, they have on the wider economy and the ordinary person’s daily life.

Photo of Mel Stride Mel Stride Financial Secretary to the Treasury and Paymaster General 2:45, 9 January 2018

Briefly, the hon. Gentleman raised a few points, including one being about HMRC and its effectiveness, particularly in advance assurances. As we know, advance assurances are a service provided on a non-statutory basis by HMRC, where a company can be given assurance on proposed investments that qualify for relief, unless the circumstances of the investment or, indeed, the law were to change. Here, assurance is being provided for investments that have not yet occurred. Clearly, HMRC cannot provide assurances for investments which, by the time they are made, may not meet a new condition that is going through Parliament. That has been a situation recently. HMRC has published a response to its advance assurance consultation, which sets out the steps it is taking with the aim of dealing with the vast majority of cases in 15 working days by this spring. That includes taking the action that we have been discussing on capital preservation.

In terms of reviews, assessments and the new clauses that are proposed, I come back to my earlier points that this whole set of changes that we are looking at around VCTs, EIS and so on, have come out of an extensive period of consultation led by Sir Damon as part of the patient capital review, in which the very questions that the hon. Member for Bootle was rightly asking in his speech were asked and consulted on in great detail. As I said earlier, there will be a report to the Chancellor on the implementation of these measures. That will happen in the Budget this year, in 2018. By autumn 2020, we will have the assessment report on the policies, including the measures that are covered in the Bill. For those reasons, I urge the Committee to reject the new clauses, and I commend clauses 14 to 17 and Government amendment 1.

Question put and agreed to.

Clause 14 accordingly ordered to stand part of the Bill.

Clauses 15 and 16 ordered to stand part of the Bill.

Schedule 4 agreed to.

Clause 17 ordered to stand part of the Bill.

Schedule 5