View more on these topics

Tony Wickenden: Making VCT and EIS investment fit for purpose

Tony WickendenNew rules aim to ensure venture capital scheme investments flow to the right businesses, not just those focused on delivering tax-motivated returns.

The tax attraction of pensions has undoubtedly been effective in encouraging investment in them over the years. Influencing people’s behaviour using tax relief and tax freedom has clearly worked. Perhaps too well in the eyes of the Government.

So, when those reliefs are limited and capped – as has been seen with the annual and lifetime allowances, for example – it is understandable that people who have been conditioned by their availability are drawn to consider other areas of investment that offer similar.

We all know there is nothing that gives quite the level of tax incentive as a pension. But venture capital trusts, enterprise investment schemes and seed enterprise investment schemes give “upfront” tax relief in the shape of a 30 per cent tax credit, or 50 per cent for the SEIS.

Phil Young: A word of warning on VCTs and EISs

There are other tax incentives for these types of investment, such as tax free capital gains for EISs and VCTs, tax free dividends for VCTs, CGT deferment for EISs, 50 per cent CGT reinvestment exemption for SEISs and inheritance tax freedom for EISs and SEISs through the availability of business relief.

Pretty compelling, right? Well, yes, but it is essential to remind ourselves that these incentives are given for a reason: to encourage investment in particular types of business.

New rules

The Chancellor reminded us of this in November’s Budget by announcing new rules to ensure venture capital scheme investments flow to the right risk-taking businesses, not just those focused on delivering predominantly tax-motivated returns.

This intention was expressed effectively alongside the results of the Patient Capital Review, which looked at ideas for increasing the flow of capital to growth-orientated (and especially high tech/knowledge-intensive) businesses.

File image of seedlings growingWhile tax was not in any way the main focus of the review, the positive role tax incentives could have in encouraging money flow to the right sort of businesses was recognised.

As a result of this, we know that encouraging investment in appropriate businesses through tax incentives is something that has been recommitted to by the Government. But we also have a recalibration of the rules around which businesses qualify for the reliefs.

So let’s have a look at these. In the general description of the measure in HM Revenue & Customs’ policy paper on “Venture Capital Schemes – risk-to-capital condition”, it states as follows:

“The measure introduces a new condition to the EIS, SEIS and VCT rules to exclude tax-motivated investments, where the tax relief provides most of the return for an investor with limited risk to the original investment (that is, preserving an investor’s capital). The condition depends on taking a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors.

The condition has two parts:

  1. Whether the company has objectives to grow and develop over the long term (which broadly mirrors an existing test with the schemes); and
  2. Whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return. The condition requires all relevant factors about the investment to be considered in the round.”

Picking apart Hammond’s changes to VCTs

In relation to the policy objective itself, HMRC states this:

“The Government wants the venture capital schemes to be focused on support for companies with high growth potential. In response to the consultation ‘Financing Growth in Innovative Firms’, evidence was provided suggesting a significant subset of EIS investment 2016-17 was focused on capital preservation.

“The risk to capital condition is a principled approach which enables the Government to avoid excluding further specific types of activity, which would risk excluding genuine entrepreneurial businesses, while reducing the opportunity to use the schemes for tax motivated investment.”

It also adds that:

“A number of specific trading activities have been excluded from the schemes since 1998 because they offer low risk investment opportunities for investors.  Most recently, all generation activities were excluded for investments made on or after 6 April 2016.

“The Government published its ‘Financing Growth in Innovative Firms’ consultation on 1 August 2017 which asked for views on reducing lower risk capital preservation investments in the venture capital schemes. The Government’s response document was published on 22 November 2017.”


Now, the conditions referenced above (and now contained within the Finance (No.2) Bill 2017) could not be more principles-based, could they? And that is what has given rise to more than a little consternation among professional bodies and practitioners.

The Association of Tax Technicians, for example, has expressed concern over them, echoed by the EIS Association.

Broadly speaking, the concerns centre on the fact Clause 14 of the Finance (No.2) Bill 2017 introduces an additional risk-to-capital condition in order for investments to qualify for any of the three venture capital reliefs: EIS, SEIS and VCT.

Assessing the relative merits of VCTs and EISs

As a reminder, the purpose of the new condition is “to prevent investment in companies whose activities are mostly geared towards the preservation of the capital invested rather than the long-term growth and development of the company”.

The company in which the investment is being made has objectives to grow and develop its trade in the long term

In relation to each of the three schemes, the new risk-to-capital condition has two legs.

With regards to all the circumstances existing at the time of the share issue, it must be reasonable to conclude both that the company in which the investment is being made has objectives to grow and develop its trade in the long term, and that there is a significant risk there will be a loss of capital of an amount greater than the net investment return.

The grow and develop test

In its written evidence to the Public Bill Committee, the ATT focused on the company objectives condition. It notes it is unclear what the requirement for the company’s objectives to grow and develop its trade means in practice.

It notes that neither “grow” nor “develop” is defined in the legislation. It explores whether there is an intended distinction in meaning between the two verbs and, if so, whether there is a risk a company’s objectives might satisfy one but not both of the grow and develop tests.

The ATT’s written evidence observes the uncertainty of meaning is compounded by the addition of the words “in the long term” which introduces an imprecise timescale and also prompts the question as to whether the new condition would be met if the company’s objectives were to grow and develop in a more immediate timescale.

Specifically within the context of the EIS, ATT asks whether the grow and develop test achieves anything given that an existing condition (Income Tax Act 2007 section 174) already requires the shares in respect of which relief is claimed to “be issued in order to raise money for the purposes of a qualifying business activity so as to promote business growth and development”.

What EISs and VCTs can bring to a retirement portfolio

VCT EISAs a subsidiary point, in relation to all three of the venture capital schemes, ATT drew attention to an apparent inconsistency between the commencement provision within Clause 14 (“that changes will take place in accordance with regulations made by H M Treasury”) and HMRC’s draft guidance which simply states the new condition “will apply to all investments made on or after the date of Royal Assent to Finance Bill 2017-18”.

The concern over definitions is palpable. Hopefully, we will see some greater clarity emerge as a result of representations that are being made.

Principles-based provisions are one thing but it would be helpful if we were a little clearer over the meaning of the principles.

Most connected with the sector were not surprised that some restrictions and tightened definitions were introduced, and there is a general sense of relief and satisfaction that the principle of the reliefs remains solid.

The need for advice on constructing and managing the most appropriate portfolio of tax-advantaged investments for clients has increased with these new provisions.

Appropriateness and suitability for any particular investor is about more than ticking the tax relief boxes. The opportunity to add real value through know-how, expertise and understanding is very real and, taken carefully, can deliver meaningful results.

Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn



Phil Wickenden: Next generation advice models

December 2012 had all the hallmarks of finality. A galactic alignment 26,000 years in the making and an historic “year zero” according to arcane texts, signalling a great end to the world as we know it. This was expected to be the day that massive solar flares were to burst off our sun, scorching the […]


Investment Uncovered: How ETFs will transform the future of wealth management

A great migration from active to passive is happening, with many benefits for advisers and clients Demand for passives has seen another record year. Research from BlackRock shows that $81bn (£57bn) was poured into ETFs across Europe in the 12 months to the beginning of January, with investors tilting exposure towards emerging markets and European […]


A warning for advisers using strategic asset allocation models

Significant gilt weightings continue to be recommended, despite concerning signals on their risk Government bonds play a pivotal role in a balanced portfolio; there are very few assets that provide the diversification benefits gilts can bring. So often over the last 30 years, when equity markets have zigged, bond markets have zagged, thereby smoothing return […]

Trevor Greetham, Royal London Asset Management

Buying the dip as volatility persists

Trevor Greetham shares his thoughts on investment allocation amid expansion in the world economy, persistent market volatility and low levels of sentiment not seen since the China devaluation panic of 2015. Read the article here Past performance is not a guide to future performance. The value of investments and the income from them is not […]


News and expert analysis straight to your inbox

Sign up


    Leave a comment