While many commentators on the autumn budget were unmoved, we welcomed various tax changes that affect the knowledge-based businesses we work with – namely, an increase in R&D expenditure credit rate and measures to shift private EIS investors’ money towards knowledge-intensive companies – as good news for the tech and biotech space. Here’s a summary of the main changes in these areas.
- R&D tax credits
There was no change to SME tax credits.
R&D expenditure credits (RDECs) are the credits available to non-large companies as well as SMEs that include grant-funded projects. The rate of credit will increase from 11% to 12% for R&D spend from Jan 1, 2018.
For loss-making companies the RDEC can be claimed as a cash payment from HMRC. But the payment is made after deduction of corporation tax. Given the falling rate of corporation tax, this means the cash rate will increase from the current 8.8% of spend to 9.96% of spend by 2020.
- Venture capital schemes
The venture capital schemes (SEIS/EIS and VCT) provide tax breaks for investors in smaller companies. The current rules allow these tax breaks whether the investment is made in an IP-rich company or a more conventional business. In addition, many investments are made with the aim of giving the investor a tax break, with little regard for the company being invested in.
Colin Hailey of Confluence Tax chairs the Finance and Tax Advisory Committee of the UK BioIndustry Association and, through this association, we have had significant input to the Patient Capital Review, a Government consultation. The FTAC has proposed improvements to the venture capital schemes, in particular to direct private investment into knowledge-intensive companies by providing greater tax incentives to those investments than to non-knowledge-intensive companies.
The autumn budget has taken up this theme, which is good news. HM Treasury has constructed the new requirements as follows.
- For all Venture capital schemes (SEIS/EIS & VCT)
‒ Implementing a new principles-based test (from the date of Royal Assent of Finance Bill 2018) to ensure the purpose of the investment is to provide funds to the company, rather than provide investors with a tax break. The test will have two parts:
- The company’s objective must be to grow; and
- there must be a significant risk of a loss of capital for the investors greater than their net return.
Based on the Treasury’s example, and the construction of the test, we do not expect this test to prevent or affect venture capital scheme investment in technology and biotechnology-based businesses.
- VCT schemes
‒ No more investment by VCTs in the form of secured loans will be permitted (from Royal Assent of the Finance Bill 2018). VCT investment in the form of share subscription and unsecure loans will still be permitted.
- EIS changes (with effect from April 2018)
‒ The annual personal EIS investment limit for an individual increases from £1m to £2m for investment in knowledge-intensive companies.
‒ The annual limit that any one company can take in as EIS investment increases from £5m to £10m for knowledge-intensive companies.
While these changes are more indirect than we would have hoped for, they are a welcome change that should begin to drive more investment towards knowledge intensive companies and provide tax reliefs to the investors who really deserve it.
- Equity incentives for employees – entrepreneurs’ relief changes
There has been no change to EMI share option schemes. A 10% rate of capital gains tax should apply on the ultimate share sale on a company exit.
For employee or director shareholdings, the 10% capital gains tax rate via entrepreneurs’ relief is currently only an option if the individual holds at least 5% of the share capital.
As companies go through successive funding rounds, this holding above 5% will become diluted and, once it goes under 5%, entrepreneurs’ relief is lost. Therefore, ultimate share sale is subject to 20% (not 10%) capital gains tax.
A rather cryptic line in the budget attempted to deal with the entrepreneurs’ relief issue with a deemed disposal and reacquisition of the shares at the time of the investment round. Presumably, the intention is to lock in the growth in value while the 5% or greater holding existed, at the 10% capital gains tax rate.
For example, say the shares were initially worthless, but were then worth £1m at the time the dilution below 5% occurred, and were finally sold when worth £5m. The £1m growth in value would be subject to the 10% capital gains tax rate, and the remaining £4m growth in value would be subject to the 20% capital gains tax rate.
In the absence of clarity from HM Treasury (to gain insight we need their planned technical consultation), concerns and questions remain. These include:
- When is the tax on the £1m paid – at the investment round or on the final sale?
- Is there real evidence that shareholders put off funding rounds in order to avoid a higher rate of capital gains tax, as the Treasury suggests?
- For many companies with preferred shares in issue, the ordinary shares that employees or directors hold have no value until very close to the final share sale, unlike our £1m/£4m example above. So there is no value to lock into the 10% capital gains tax rate and this proposed rule change adds nothing.
Overall, these changes show an encouraging shift towards investment in knowledge-intensive companies and we look forward to the future to see how this may have a positive impact within the biotechnology and technology space in the UK.
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