" Advisers are going to need to know and understand the investment managers they recommend, and have an understanding of the type of investee companies who might receive that investment. "
Of course, moving from a Budget to legislation takes some time but earlier this year the Finance Bill received its Royal Asset which heralded a new era for the tax-efficient sector, and in the case of EIS/Seed EIS actually reverts the market back to how it had been originally envisaged.
Back in March this year we saw a significant change introduced in this sector, and one that advisers working with tax-efficient investments need to be fully aware of, the introduction of the HM treasury’s ‘Risk to Capital’ condition. This is a significant advancement for the EIS/SEIS investment landscape as it forms the bedrock of the HMRC’s decision making when it comes to considering the ‘Advance Assurance’ applications from those companies who want to secure investment via the Enterprise Investment Scheme.
You will have heard a lot about EIS/SEIS now moving away from propositions which are ‘capital preservation’ focused. The aim, in this new environment, is not to allow EIS schemes to run as ’low risk’ enterprises for its investors, but instead there must be a tangible and discernible risk to the investment, and therefore those companies looking to receive any investment – from managers like ourselves – need to demonstrate adherence to the criteria.
At Deepbridge we will soon be launching a ‘Guide to EIS’ outlining the ‘new world’ for advisers and their tax-efficient investors, but in the meantime here is a brief run-down of the level firms must reach in order to achieve ‘EIS qualification’. As mentioned, HMRC sets prescriptive EIS qualification criteria for companies such as:
• Any investment must be purchasing new shares (rather than acquiring existing shares).
• The company must be established in the UK.
• The company must have fewer than 250 employees.
• The company has gross assets of £15m or less before investment (or £16m after investment).
• EIS investment in a singular company does not exceed £5m in any one year (up to £10m if it can meet the ‘Knowledge Intensive’ criteria, pending EU State Aid approval).
• The company must use the investment within 24 months.
• The company cannot be controlled by another company.
• The company must operate a qualifying trade.
• There are a number of excluded industry sectors, predominantly in and around financial services, renewable energy and property.
• The company must meet the Risk to Capital condition
So, what about the ‘Risk to Capital’ condition - what does it truly mean now it’s been introduced? Firstly, investee companies must intend to grow and develop their trade long-term and there must be a ‘significant risk’ of a capital loss, i.e. it is a genuine business with the intention to grow and not a contrived vehicle seeking to limit investor risk. ‘Significant risk’, in this case, is not specifically defined and is reviewed on a case-by-case basis by HMRC. In order to assess the tests, regard must be paid to all circumstances but the legislation particularly references:
• The company’s intent to increase the number of employees, turnover or customer base.
• The nature of the sources of income, including the risk of not receiving it.
• The extent to which the company has assets that could be used to secure financing.
• The extent to which activities are subcontracted to unconnected parties.
• The ownership structure.
• How the investment is marketed.
• The extent to which the investment is marketed with or linked to other investments.
If you were thinking HMRC will not be particularly rigorous in determining the nature of investee companies and whether they might meet the above, in its own internal guidance it indicates it will carry out post-investment checks on companies to see if the risk to capital condition has been met, as well as reviewing if the money raised has been used in accordance with the information provided in their compliance statement. Following these checks, HMRC will be able to withdraw relief if the conditions are not met and advance assurance cannot be relied upon if the full facts were not provided to HMRC.
In other words, none of us should expect this to be a tick-box exercise which won’t be reviewed again – given the emphasis the Government has placed on these changes, and the anticipation of the boost this will give to firms that want to receive investment, and therefore have to meet the criteria, it will not be a rubber-stamping exercise.
In that respect, advisers are going to need to know and understand the investment managers they recommend, and have an understanding of the type of investee companies who might receive that investment. Understanding how closely the investment managers works with underlying investee companies is important, as this may determine how they may ensure investee companies continue to adhere to their EIS Advance Assurance criteria. Were the manager to get it wrong, then the consequences could be very serious for all concerned parties. This Risk to Capital condition is a marked game-changer for our sector and advisers should make sure they are dealing with those that understand it and will not fall foul of the changes later down the line.
