Government plans for new incentives could lure more investors to so-called ‘knowledge-intensive companies’

Along with the “stick”, in the shape of provisions limiting relief for investment into venture capital trusts and enterprise investment schemes, there is the “carrot” of increased investment limits for knowledge-intensive companies.

While knowledge-intensive companies have become a talking point of late, following announcements around them in November’s Budget and then last week’s Spring Statement, they are not a new concept.

The £15m risk capital amount limit, set as the total amount a company can raise under an EIS or VCT arrangement, has been in force since the March 2015 Budget.

Spring Statement: Govt launches consultation on venture capital funding

At the same time, the Government also set £20m as the total investment cap for knowledge-intensive companies. It also declared an increase in the allowable number of employees for knowledge-intensive companies that raise money through the EIS to 499 employees.

Further changes followed in the July 2015 Budget. As part of those changes, the law required that companies raise their first EIS or VCT investment within seven years of its first commercial sale. Knowledge-intensive companies were given a 10-year limit.

Recent changes

The announcements in relation to knowledge-intensive companies in last year’s Autumn Budget grabbed headlines, being part of a raft of wider changes aimed at driving greater amounts of capital investment to such firms.

First, the Government doubled the amount that can be invested by individuals through an EIS from £1m to £2m from 6 April, provided any amount above £1m is invested in knowledge-intensive companies.

The annual investment limit for knowledge-investment companies will also increase from £5m to £10m through EISs and VCTs from 6 April.

Tony Wickenden: Making VCT and EIS investment fit for purpose

So what exactly makes a company knowledge intensive?

The key test is that it meets the operating costs condition, plus either the innovation condition or the skilled employees’ condition, by the time the share issue takes place. Let’s take a look at those in a little more detail.

Operation costs condition

The operating costs condition stipulates the following:

1. To be knowledge intensive, a company must have spent at least 15 per cent of its operating costs on innovation and/or research and development in at least one of the three preceding years. The operating costs are the expenses reflected in the profit and loss account or income statements excluding those incurred intra-group.

2. Further, the company should have allocated 10 per cent of the operating costs in each of the three preceding years to R&D.

Innovation condition

This requires the issuing company to illustrate it has created or is in the process of creating intellectual property at the share issuing time.

The company should also illustrate it is reasonable to assume that, within 10 years of the share issue,
the use or exploitation of the intellectual property to create new products will form the larger part of the company’s business.

Skilled employees’ condition

This stipulates at least 20 per cent of the company’s full-time employees should hold a higher education qualification and be directly involved in its R&D and innovation.

With greater numbers being caught by the annual and lifetime allowances, interest in investments that generate front-end tax relief is only likely to increase.

This is especially so given other tax advantages these investments can deliver, such as capital gains tax deferment of past gains (EIS), CGT freedom of future gains (EIS and VCT), tax-free dividends (VCT) and inheritance tax freedom (EIS).

To secure the tax advantages, the investor will need to be comfortable with the level of risk they are taking. This will continue to be so given the Government’s commitment to ensuring the generous reliefs for tax-advantaged investment are only available to those prepared to take the appropriate risk.

In last week’s Spring Statement, a further consultation in relation to knowledge-intensive companies was announced. In launching it, HM Revenue & Customs stated:

“As part of the Patient Capital Review reforms to promote high-growth and innovative investment, the Government is consulting on the introduction of a new approved fund structure within the EIS, with the possibility of additional incentives to attract investment. Such a fund structure would be focused on mainly investing in knowledge-intensive companies.

“This consultation outlines and seeks views on possible elements and constraints of such a fund structure, while also seeking to better understand the capital requirements of innovative knowledge-intensive companies.”

The consultation closes at 5pm on 11 May.

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