Government plans EIS tax benefits

The government has sought feedback on four EIS fund models to direct capital into knowledge-intensive companies, arguing the structure is best placed to stimulate investment into the early-stage companies.

Government plans EIS tax benefits

The new model would exist alongside the current EIS scheme, but would have different tax incentives to encourage inflows into the higher-risk investments.

Dividend tax exemption, capital gains tax (CGT) relief, extended carry-back of income tax or CGT deferral and up-front tax relief were all listed as models the government could introduce to encourage inflows to EIS funds investing in knowledge-intensive companies.

Consultation on the document will be open until 11 May.

Wealth Club founder Alex Davies said the new rules would encourage investment into companies similar to Dyson, ARM Holdings and Abcam, which “can only be a good thing”.

Currently investors receive an up-front tax credit for EIS and SEIS investments worth 30% and 50% respectively together with CGT reliefs and further income tax relief if an investment is ultimately sold at a loss.

The government has argued the EIS is more suitable for its needs as VCTs have traditionally been focused on later-stage investments, although it acknowledged that might change in future.

The 13-page consultation document noted any new fund structure must: attract investors while not distorting the market; avoid unfairness in the tax system; deliver economic benefits in line with the cost; and deliver tax advantages proportionate to the market failure adversely affecting knowledge-intensive companies.

It said funds that would benefit from the tax advantages would have to invest almost entirely in knowledge-intensive companies, but said up to a fifth of the fund could be in non-knowledge-intensive EIS businesses.

Davies said: “The one thing the government should avoid at any cost in my opinion is to introduce further complexity. However good the government’s intentions, and however great the benefits, if the rules are too complex investors will be put off.”

The government acknowledges the changes may come into effect before Brexit and therefore must meet European Union state aid rules. The consultation noted existing EIS, SEIS, and VCT rules are already among the most generous of their kind in Europe.

The proposed models

  • Dividend tax exemption

Under this model, investors would not pay tax on dividends received from knowledge-intensive companies after a fixed holding period, which the government suggested would be five or seven years.

The consultation document raised two potential problems with this model.

On the one hand, it said shareholders would pressure companies into paying dividends instead of reinvesting in their businesses. On the other hand, it noted the primary motivation for investment in high-growth companies is capital gains rather than income.

  • Capital gains tax relief

The EIS currently allows investors to defer CGT on gains if proceeds are reinvested in EIS qualifying companies.

The consultation document proposed investors could instead write off a proportion of a capital gain on reinvestment into a knowledge-intensive fund.

  • Extended carry-back of income tax or CGT deferral

Existing EIS rules let investors set their income tax credit against tax liabilities in the year of investment or the prior year.

The consultation proposed this could be widened to permit a further carry-back for investors in knowledge-intensive funds.

  • Up-front tax relief

The up-front tax relief model addresses the fact investors currently receive relief at the time an unapproved fund invests rather than when they contribute capital to the fund. For approved funds they can claim tax relief for the tax year the fund closes, as long as the fund manager invests 90% of funds raised within 12 months.

The alternative proposal therefore suggests up-front tax relief on the condition capital is invested during a specified time period, possibly two years.

However, the consultation document notes regulation would have to be introduced for capital awaiting investment, for example in bonds or cash. It would also be necessary to introduce new compliance processes to withdraw relief if the fund ceases to be eligible.

The document said this model was particularly complex.

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