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-inteSeed Enterprise Investment Schemesnsive 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 in 2011, its objective being to ‘stimulate entrepreneurship and kick start the economy’ following the 2008 banking crisis.
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 Enterprise Investment Scheme (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.
In his Spring Statement of 15 March 2023, chancellor Jeremy Hunt confirmed that the changes announced by his predecessor, Kwasi Kwarteng, in his ‘mini budget’ of September 2022 would come into effect on 6 April 2023, ie: the amount of investment a qualifying business could raise would be increased from £150,000 to £250,000; the gross asset limit raised from £200,000 to £350,000 and, to support this, the annual investor limit would be doubled to £200,000.
For a business to qualify for investment under the Seed Enterprise Investment Scheme, it must be based in the UK, 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. Also confirmed in the Spring 2023 Statement was the limit on the length of time the business had been trading; this being increased from a maximum of two years to a maximum of three years with effect from 6 April 2023.
Investors can receive up to 50% tax relief in the tax year the investment is made, irrespective of their marginal rate.
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.
You can invest a maximum of £1 million per year in EIS qualifying schemes, or £2 million per year if at least £1 million of that figure is invested in knowledge-intensive companies. Generally, the minimum investment is £10,000 per year. Investment can be made by either investing directly in a qualifying business or using a fund manager as an intermediary. 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 carry out a ‘qualifying trade’; have a permanent establishment in the UK; have been trading for at least four months, not be trading on a recognised stock exchange; not be controlled by another company (with exceptions); not have more than 50% of its shares owned by another company; have fewer than 250 employees and have no more than £15 million in gross assets. The qualifying criteria for those firms considered to be ‘knowledge intensive’ are slightly different.
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.
Individual investors buying shares in a VCT qualify for a number of tax benefits, including tax relief of up to 30% if the investment is in newly issued VCT shares, tax-free dividends and no Capital Gains Tax. The maximum you can invest is £200,000 per year.
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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