Tony Mudd: EIS providers risk sabotaging their own sector

 Tony Mudd

Small and medium-sized businesses are the lifeblood of the UK economy, and appropriate levels of finance – debt or equity – are critical to their development and continued success.

It is no surprise, then, that governments past and present have been keen to encourage investments into this vital sector of the economy. They do this by co-investing with individuals prepared to take the risk of putting money into small, unquoted trading companies through the provision of generous tax incentives – otherwise known as enterprise investment schemes.

The current EIS market is estimated to be worth about £1.5bn. It is driven by a combination of investors looking for tax-efficient options and ways to get access to a section of UK business that will drive growth over the next few decades, and by successive governments that want to encourage such behaviour.

Such an environment has created a ‘perfect storm’, and a constant flow of new providers with variations of offerings, asset classes and risk profiles means the products now sit firmly in the retail space.

EISs undoubtedly remain in the higher-risk category from both a pure investment and liquidity perspective but they should be on every adviser’s agenda for clients in the high net worth and mass affluent sectors. While the tax incentives have changed over the years they have retained their capacity to de-risk the investment.

What is more, in an environment where the term ‘tax avoidance’ has become synonymous with ‘tax evasion’, and even ‘tax mitigation’ is a term to be handled with care, the provision of statutory tax relief from an EIS should not be easily dismissed.

The European Union takes a keen interest in this area, given that the tax reliefs provided for EISs fall under EU state aid rules. With this in mind, we have seen consistent targeted intervention, with solar energy, reserve power and, most recently, all energy-generating infrastructure becoming excluded activities.

The 2015 Finance Act continues this tinkering, and while constant change is not helpful, the reality is the industry only has itself to blame. As with many facets of financial services, there will always be providers that push the envelope, particularly where tax incentives are available. In my view, they are in danger of sabotaging their own sector. After all, the spirit to which the Treasury would like providers to adhere to is crystal clear.

Amendments in the Finance Act to ITA2007 S174 (now contained in the new S174 (2)) requiring funds raised through EISs to be used for business growth and development, plus the Treasury’s stated view that such funds should be for situations where normal private equity would not be readily available, make it clear the Government is trying to direct EIS funds to genuine entrepreneurs.

The biggest reason for business failures is lack of cash and, while debt finance is, and will remain, an important funding source, it does not come without its own problems. EISs have a significant part to play in providing alternate, equity finance. They also provide a good balance in terms of value and return for investors, as well as for the Treasury and for the businesses themselves.

It is time to get behind these small businesses. Many are thriving already but EISs have the capacity to do so much more for them. Within this, advisers have an essential role to play. The only real danger to this sector is those providers of EIS funds that continue trying to force the boundaries.

Tony Mudd is divisional director of tax and technical support at St James’s Place