Budget 2007: What It Means For Angels & VCs
Linda Roberts
05-Apr-07
Budget Day is always a time of trepidation for investors, and never more so than when it is being delivered by Gordon Brown, the political showman, the master of the “giving in one hand” and “taking away in the other” trick. His micro meddling with financial affairs has grabbed the headlines with what appear to be substantive changes, particularly those regarding tax cuts, but the reality is quite different. By 2009/10, when most of the announced tax measures have taken effect, the Treasury will on balance have relieved us of a further £125 million in tax.
At first glance the changes affecting angel investors are obvious: the tax privileged investment schemes. In reality, anything that effects a start-up business’ decision on location, capital expenditure, research and development (R&D) and a host of other factors ultimately affects investors. Similarly, measures targeted on specific industry sectors affect investment choices. We do not intend to cover the Budget in full in a single article, but hopefully we can address some of the aforementioned topics that may affect your investment decisions.
Sideways Loss Relief
But before we get to the Budget, another trick from the Treasury is to slip in unwelcome tax changes as the moment takes it. One tax change that slipped in before Budget day was the restriction of ‘sideways loss relief’ available to individuals who carry on a trade in partnership. This relief encouraged individuals to invest in high-risk ventures by allowing them to write off initial losses against their tax bill while opening up the opportunity for (taxable) profits if the venture succeeded. The relief is a common feature of investment partnerships and reduces the initial risk for investors - making it easier for businesses operating in high-risk sectors to attract start-up funding. Smaller ventures in high-risk industries such as the bio-tech industry and “green” research will be particularly hit by this change as they often rely on start-up funding from individual wealthy investors.
From 2 March 2007 capital contributions paid by non-active partners will be excluded from the calculation of trading losses for sideways loss relief where the main purpose (or one of the main purposes) for contributing the capital to the partnership is for the partner to have access to losses for which sideways loss relief can be claimed. (A non-active partner is defined as one “who spends an average of less than 10 hours a week personally engaged in carrying on the partnership’s trading activities”.) A new annual limit will also apply to trading losses sustained as a non-active partner on or after 2 March 2007. The limit for each tax year, for trading losses from all partnerships in which the individual was a non-active partner for that year, will be the lower of £25,000 or the amount of trading losses for the tax year for which the individual would otherwise be able to claim sideways loss reliefs. These measures will adversely affect both angel investors and high-risk start-up companies who may find it harder to find alternative funding.
The timing of the announcement with its immediate effect is seen as a move by HM Revenue & Customs to restrict losses by foiling the plans of individuals who intended to invest in partnership loss schemes before the end of the tax year 2006/07. Following requests from the film industry, HMRC later announced that certain qualifying films would not be subject to the new announcement – another Government U turn. Tax privileged investment schemes Perhaps the most significant announcement in the Budget 2007 for angel investors is the changes to the various tax privileged investment schemes. The changes will affect investors under the Enterprise Investment Scheme (EIS), the Corporate Venturing Scheme (CVS) and the Venture Capital Trust (VCT) scheme, companies attracting investment under those schemes, VCTs and companies using Enterprise Management Incentives (EMI).
An employee test and an annual investment limit have been introduced in response to the publication of the new State Aid for Risk Capital Guidelines by the European Commission. The guidelines cover risk capital measures for investment in SMEs in their early stages (seed, start-up and expansion), where funding is provided jointly by the state and private investors. The Government claims that the changes will give greater certainty to investors and the companies they invest in, and will secure the future of the schemes. Savings from these changes will be used to fund enhancements to R&D tax credits. However the Government also acknowledges that the changes will impact the effectiveness of the schemes by reducing permitted investments; it has therefore written to the European Commission calling on it to review the way in which it applies State Aid guidelines.
EIS, VCTs, CVS: The employee test
A company (or group of companies) raising money under the venture capital schemes (EIS, VCT and CVS) schemes will be required to have fewer than 50 full-time employees (or their equivalents) at the date on which the relevant shares or securities are issued.
EIS, VCTs, CVS: The investment limit
A new investment limit will apply to a company raising money under the venture capital schemes. For an “investment” to qualify for relief under the EIS or CVS, or be treated as a qualifying holding of a VCT, the company (or group of companies) must have raised no more than £2 million under any or all of the schemes in the 12 months ending on the date of the relevant investment.
If the limit is exceeded, none of the shares or securities within the issue that causes the condition to be breached will qualify for relief under the EIS or CVS, or rank as a qualifying holding for a VCT.
For the purpose of this test an “investment” will be any investment made by a VCT from funds raised on or after 6 April 2007. For EIS and CVS the new limit will apply to shares issued after the date on which the Finance Bill receives Royal Assent. The employee test and investment limits will not apply in relation to investments made out of funds raised by VCTs before 6 April 2007, nor to EIS or CVS shares issued before the date on which the Finance Bill receives Royal Assent.
EIS, VCTs, CVS: 90% subsidiaries
Current rules require that where a qualifying trade is carried on by a subsidiary company that company must be a direct qualifying 90% subsidiary of the parent company. From 6 April 2007 a qualifying trade will be allowed to also be carried on by subsidiaries that are 100% subsidiaries of direct 90% subsidiaries of the parent, or 90% subsidiaries of direct 100% subsidiaries.
This relaxation will remove a current obstacle to joining the scheme and therefore help companies with subsidiaries seeking finance.
VCTs: The 70% qualifying holdings rule and nonwithdrawal of approval
Currently a VCT is required to keep at least 70% of its investments in qualifying holdings at all times to retain approval or it will lose its qualifying status. In some cases a VCT may be unable to dispose of a holding without breaching this condition. This has been recognised as unreasonable and HMRC is to be given the power to make Regulations to overlook inadvertent breaches of the rules in certain circumstances.
From 6 April 2007 when a VCT makes a cash realisation on the disposal of an investment that has been part of its qualifying holdings for at least 6 months; the disposal will be ignored for the next 6 months for the purpose of the 70% test. This will allow the VCT to breach the qualifying requirement by giving it up to 6 months to reinvest or distribute the disposal proceeds.
EIS: Approved funds
If an EIS fund is approved, investors can claim EIS income tax relief on their subscriptions as if those subscriptions had been made on the date the fund closed. Under current rules this is conditional on funds being at least 90% invested within 6 months of the closing date.
For approved funds with a closing date on or after 7 October 2006 this 6 month period will be extended to 12 months. EIS, VCTs, CVS and EMI: Relevant intangible assets The current rules restrict the transfer of a qualifying trade of exploiting relevant intangible assets (RIAs) - e.g. intellectual property - around a group of companies.
New rules will be introduced from 6 April 2007 to align the rules relating to the transfer of that trade with those currently relating to other qualifying trades so that RIAs can be moved around within groups without investors losing tax relief and EMI companies losing their qualifying status.
Corporation Tax and Capital Allowances
A cut in corporation tax always “sounds” good and may encourage some multi-national companies to move to Britain – or British companies to stay put. But that depends on the type of company. Service based companies will benefit most from the cut in the main rate of corporation tax from 30% to 28% from 1 April 2008. Manufacturing companies that by their nature invest in capital equipment will not fare so well. The cuts in capital allowances could significantly offset any financial benefit they accrue from the tax reduction and are expected to hit cashflow in the short term. This is evidenced by the forecast that the Treasury is expected to lose £1.38bn in the fiscal year 2008/9 from corporation tax receipts but receive £1.49bn in the same year through changes to tax relief on capital expenditure.
Small companies will bear the brunt of funding the tax cut for larger businesses with an increase of 3% over two years in the small companies’ rate on profits below £300,000. One small concession is the predictable extension of the 50% rate of first-year allowances for small enterprises until 31 March 2008. Many small business associations and trade associations responded angrily to the increase which is expected to raise £820 million in additional tax from small businesses.
The phasing out of capital allowances for industrial buildings will fall particularly hard on the manufacturing sector. The reduction in the available allowance on most qualifying shorter life plant and machinery from 25% to 20% will increase the tax burden further. The increase in the rate for longer-life assets (about 25 years) from 6% to 10% will however encourage infrastructure investment.
Other changes being implemented from April 2008 include a new annual investment allowance for the first £50,000 of expenditure on plant and machinery, the limiting of the allowance on certain fixtures integral to a building to 10% and the introduction of a payable tax credit for losses resulting from capital expenditure on certain designated “green technologies”. Businesses will need to consider their timing and choice of capital investment carefully over the next few years to best take advantage of these changes.
Business Premises Renovation Allowance will come into effect for qualifying expenditure incurred on and after 11 April 2007. It will provide 100% initial allowance for capital expenditure on the renovation or conversion of business properties that have been vacant for a year or longer in designated disadvantaged areas of the UK.
Research and Development
Research and development expenditure is often an important agenda item for the type of start-up companies that angel investors back, and here there is some good news. From 2008-09 the rate of enhanced deduction available to SMEs in respect of qualifying research and development expenditure will increase from 150% to 175%. The value of the payable tax credit will remain broadly at its current value of 24% of qualifying expenditure. For large companies the rate of enhanced deduction will increase from 125% to 130% - not generous enough to make a real impact.
A fresh investment of £1.3 billion in science and technology was settled. Total spending on science from both the education and trade and industry budgets will rise from £5 billion in this financial year to £6.3 billion by 2010-11, a 25% increase. This is particularly welcome after the recent £68 million cut in science spending to compensate for loss-making enterprises elsewhere.
A £100 million competition was also announced in the Budget: the Collaborative R&D programme will provide funding for UK business to research and develop new technologies from environmentally friendly low carbon projects to leading edge manufacturing.
Industry Measures
Gambling
Angel investors are by their nature risk-assessing, educated gamblers. However, anyone thinking of investing in the gaming industry in the UK may need to recheck their figures. The industry had expected the Chancellor to incentivise operators back to the UK but his new measures have caused industry analysts to predict a decline in investment in new and existing sites. Lady Cobham, chairman of the British Casino Association, which represents over 90% of domestic operators, estimated that the changes would cost operators £100 million over three years.
A new Remote Gaming Duty of 15% – five times the industry’s expectation – is expected to be brought into force on 1 September 2007. The duty will be levied on the profits derived from the playing of a game of chance for a prize by the use of remote communication – for example, the internet, telephone or television. It is a particular blow for the internet gambling industry and will discourage such companies from locating in the UK when competing foreign countries offer low or zero duty levels.
All casinos face hikes in gaming duty - the tax applied to the amount placed as bets minus the winnings paid out. From 1 April 2007: the 2.5% starting rate of gaming duty is being abolished; the 12.5% rate increases to 15%; and a new rate of 50% is introduced on gross yield from gaming in excess of £10 million per accounting period. The latter figure will raise financial concerns for the casino operators bidding to run the “supercasino” or one of the 16 other casinos that were announced in January.
Green industries
Green investment opportunities did receive a welcome boost. The Chancellor announced that the Government was inviting proposals to build Britain’s first carbon capture and storage facility to stop carbon dioxide emissions from power plants being pumped into the atmosphere. The successful proposal will be used in trials to assess the technology.
Closer to home, financial assistance is being made available for installing insulation and energy-efficient central heating. Funds available to householders to install solar panels and wind turbines and similar technologies are being increased from £12 million to £18 million over three years. The allotment of grants available this month was allocated in just over an hour, a sure sign of consumer interest in green technologies. Stamp duty exemptions will be available for new carbon zero homes sold for up to £500,000.
Funding for advice agencies and energy audits is also being increased from £140 million to £240 million to encourage businesses to reduce carbon emissions.
So what does all this mean for investors? As Richard Lambert, director-general of the CBI so aptly put it: “The business sector as a whole will not be popping the champagne corks… There will be losers as well as winners.” On a positive note, VCTs have been granted more flexibility on the disposal of assets and the relaxation of the qualifying subsidiaries rule will help companies with subsidiaries seeking finance. Countering this, companies raising money under a venture capital scheme will have restrictions on the amount they can raise and the number of full-time employees they can employ. Large companies may see a decrease in their tax, but at the price of reduced capital allowances. Small companies will be hit by tax increases, unless they can justify large capital expenditure or R&D. It is a “swings and roundabouts” Budget that needs careful examination. The Presbyterian message however rings out loud and clear: green is good, gambling is bad.
