Tax-advantaged venture capital schemes
To prevent it from becoming stagnant, the economy relies on a steady stream of new, innovative ideas being successfully developed and ‘brought to market’. To support this process, the government has created four venture capital schemes designed to help small to medium-sized businesses (SMEs) and, more recently, not-for-profit organisations, find the financial backing they need.
The schemes work by offering an incentive to potential investors; those who buy or hold shares, bonds or assets for a specified period of time become eligible for tax relief, a reward for investing their money into new businesses in a sector that’s known for low liquidity and a high risk of financial loss.
To qualify for any of the schemes, the business must meet a number of criteria:
- it must be based in the UK
- it cannot buy or sell its shares on a stock exchange at the time of the investment
- it must make its first sale within seven years (within 10 years if it’s a knowledge-intensive company)
- it must meet the individual scheme’s specific qualifying requirements
Most trades, including research and development which leads to a qualifying trade, qualify, but there are some significant exceptions including farming, property development, running a hotel or nursing home and generating electricity, heat, gas or fuel.
Although there’s no minimum amount that can be raised, a maximum amount is specified by each scheme. In addition, the total that can be raised by benefiting from more than one scheme is £5 million in any 12 months and £12 million during the lifetime of the business. An exception to these limits is if the business carries out research and development and meets a number of other conditions.
1. Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) was introduced by Chancellor George Osborne in his 2011 Autumn Statement, its objective being to ‘stimulate entrepreneurship and kick start the economy’ [following the banking crisis]. The statement also made changes to both the, by then, seventeen-year-old Enterprise Investment Scheme and the slightly more recent venture capital trust scheme.
The Seed Enterprise Investment Scheme is aimed specifically at new, entrepreneurial enterprises looking for ‘seed capital’ to help them get started; a necessity that usually precedes their gaining funding from the richer financial opportunity offered by the EIS with which to continue developing their business. The SEIS follows the tried-and-tested format set by the EIS of offering tax benefits to investors in return for investment and has become one of the most respected government-backed schemes ever created.
A qualifying business is limited to raising a maximum of £150,000 from SEIS investment. Investors can invest a total of £100,000 in a single tax year but this has to be spread over a number of companies as investors can have neither more than a 30% stake nor a controlling share in the business.
Investors can receive up to 50% tax relief in the tax year the investment is made, irrespective of their marginal rate.
For a business to qualify for investment under the Seed Enterprise Investment Scheme, it must be based in the UK, have been trading for less than two years, have fewer than 25 employees and have no more than £200,000 in gross assets – figures that underline the scheme’s objective of helping brand-new businesses.
2. Enterprise Investment Scheme (EIS)
The Enterprise Investment Scheme (EIS) was launched in 1994, replacing the Business Expansion Scheme as a method of encouraging investment in new businesses that were trying to grow. During the 2014-15 tax year, over £1.8 billion was invested under EIS; the cumulative total since the scheme’s launch reaching £14.2 billion which had been invested into approximately 25,000 companies.
An investor can place up to £1 million in EIS qualifying schemes each year, either investing directly in a qualifying business or doing so via a fund manager. For inexperienced investors the fund manager route is the safer option as they tend to exclude companies that are still in an embryonic phase, focusing instead on inherently lower-risk operational projects.
Income tax relief at 30% of the cost of the investment is available at the time of making the investment although the shares then have to be held for a minimum of three years. Similarly, providing the shares have been held for the three-year period, no capital gains tax applies when the shares are sold.
For a business to qualify for investment under the Enterprise Investment Scheme, it must have been trading for at least four months, have fewer than 250 employees and have no more than £15 million in gross assets.
3. Social Investment Tax Relief (SITR)
Social Investment Tax Relief (SITR) was introduced on 6 April 2014 specifically to encourage investment in charities and social enterprises; effectively, it’s the not-for-profit sector’s equivalent of the Enterprise Investment Scheme, providing the sector with a source of investment income.
In concept, the scheme is very similar to the EIS and could be seen as an alternative investment vehicle for investors who prefer to invest in charitable / community-based organisations rather than commercial enterprises. In reality, despite the many similarities in both its structure and operation, there are several major differences, one of the most significant being the level of investment income an organisation can receive. In January 2017 the government announced a number of changes to the scheme would be introduced as of 6 April 2017, including increasing the total amount of investment that could be received under a SITR over its lifetime to £1.5 million – this versus the £5 million per year / £12 million lifetime amount stipulated by the Enterprise Investment Scheme.
For a business to qualify for investment under the Social Investment Tax Relief scheme, it must be a Social Enterprise, eg: a registered charity, community interest company or community benefit society, have fewer than 250 employees and no more than £15 million in gross assets.
4. Venture capital trusts (VCTs)
Introduced by the Finance Act 1995, venture capital trusts (VCTs) are investment companies listed on the London Stock Exchange specifically to invest in small, unlisted UK SMEs. They are closed-ended, collective investment schemes designed to encourage investment by providing private-equity capital to the business and income or capital gain for investors. In the 2015-16 tax year, venture capital trusts raised £458 million, a 70% increase over the previous year’s total of £270 million.
Venture capital trusts can be classed as either ‘limited life’, if they are to be wound up after the minimum fund-holding period of five years so that the trust’s assets can be distributed amongst its shareholders, or ‘evergreen’, if it has been set up to invest over an indefinite period. Within these two broad classifications, venture capital trusts can be either ‘generalist’, if they invest in a diverse range of industries, or ‘specialists’, if they focus on a specific sector. In addition, venture capital trusts may be described by the type of company they invest in: some will invest exclusively in AIM-listed* companies, some in unquoted companies and others in a mixture of the two.
* AIM is the London Stock Exchange’s ‘Alternative Investment Market’. Launched in 1995 it allows small, less-viable companies to float shares within a relatively flexible regulatory system. Three indices are used to measure AIM: the FTSE AIM UK 50 Index, the FTSE AIM 100 Index and the FTSE AIM All-Share Index. Investors wanting to invest using venture capital trusts can only invest in UK-based enterprises.
VCT managers have a maximum of three years to invest the trust’ fund, by which time at least 70% of its assets must be invested in ‘qualifying holdings’ which are defined as being holdings of shares or securities, including loans of at least five years, in either unquoted companies or those traded on the AIM. The remaining 30% of the trust can be invested in other areas. Although a VCT can invest up to £5 million in a qualifying company, the amount invested cannot exceed more than 15% of the trust’s assets.
Investors buying shares in a venture capital trust qualify for tax relief at 30% of the amount paid for the shares, along with exemption from both income tax on dividends and capital gains tax when the shares are sold.
For a business to qualify for investment from a venture capital trust, it must be a UK-based business, have fewer than 250 employees and no more than £15 million in gross assets.
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