Mark Brownridge, Director General of EISA and formerly a financial planner himself sets out how the changes to EIS following Chancellor Hammond’s Budget last November, are likely to affect advice given by advisers and planners.
So there we have it. Last November’s Budget laid clear the future direction of EIS and SEIS. Like it or loathe it, the Government has at least set out a coherent, logical future pathway for EIS and SEIS.
Certainly, given the speculation before the Budget and some of the early conversations we at EISA were having with HMRC and HMT, the Budget feels like a strong vindication for both EIS and SEIS. Many of the suggested doomsday scenarios never transpired and it’s plain to see that the respondents to the review were glowing in their praise of EIS with the Budget paper quoting “government support through the venture capital schemes as crucial to the growth of investment over recent years”.
Before we look at the Budget changes themselves, it’s important for us to consider the bigger picture.
Firstly, it was interesting to read the Patient Capital Review Industry Panel response which was fulsome in its advocacy of EIS and SEIS quoting “The tax incentives provided for investing in start-ups through the EIS and VCT schemes have proven extremely successful in attracting funding to help stimulate a vibrant start-up ecosystem in the UK. Entrepreneurs view the schemes highly favourably, and many believe that at least one of the schemes has played a key role in their ability to start and begin to grow their businesses.” The report recommended a number of expansions to EIS and SEIS including “In 2015/16, a total of c.£2.1bn was invested via EIS and VCT. It is estimated that up to £1bn of additional capital could be raised annually through expanding or removing the cap on lifetime investment for EIS / VCT investments, especially given the enduring popularity of the schemes amongst investors.” This gives us a big clue as to where the idea for expanding the knowledge intensive limits were born (there’ll be more on that later).
Similarly, three of the keywords that cropped up time and again when we conversed with HMT were growth, innovation and technology. On reading the Industrial Strategy white paper, again it is easy to spot the origins of this. The Government is keen to help small businesses to achieve much larger scale than many currently do, certainly when compared to the US and they have identified particular sector horses to back in life sciences, AI and data, creative, automotive and technology. Thus we see new sector deals for these areas as well as a £2.5BN investment fund incubated by the British Business Bank and the seeding of a series of private sector fund of funds of scale, with a first wave of investment of up to £500m.
Given this backdrop, its perhaps easier to understand where and why the Budget has landed as it has in EIS land. The Government has identified that the UK is a great and successful place for starting up a business but that we have difficulty in scaling enough of those companies up to become the next large corporates that will drive sufficient productivity, employment growth and tax revenue. EIS and SEIS have been significant contributors to the start-up success story and it is now time for that success to contribute to building a new generation of innovative, growth-orientated companies.
This is a positive move for EIS and should be embraced. By HMT’s own admission, at times over the past few years they have encouraged EIS investment into areas not traditionally associated with growth investment to meet specific economic and political needs and this has focused attention away from the original spirit and intention of EIS and SEIS. The Budget was an attempt to turn the tide back the other way. Whilst that will mean a change of investment approach for some EIS fund managers, surely it is hard for anyone to argue against this being the correct approach.
So, what we have ended up with?
In summary, the following are the main details to be aware of:
- No cuts to tax relief, investment limits or holding periods and no exclusions of any investment activities or sectors. This is a good start.
- Increases to the knowledge-intensive investment limits. Very encouraging.
- The introduction of a new principles-based test, called the “Risk to Capital” condition specifically aimed at “tax-motivated investments, where the tax relief provides all or most of the return for an investor with limited risk to the original investment (i.e. preserving an investor’s capital)”. The condition consists of two parts and takes a “reasonable” view as to whether an EIS/SEIS investment has been structured to provide a low risk return for investors. One to watch!
- A commitment to reduce the Advance Assurance application waiting time to 15 days by Spring 2018. Amen!
So, we now know where we are heading but what’s still not clear is how we get there.
The next few months will be absolutely crucial in assessing how the risk to capital condition will be interpreted and implemented by HMRC. There still may be a sting in the tail and if EIS providers don’t heed the specifics of the new condition, it seems likely that HMRC will refuse a significant number. No doubt a few schemes will take the opportunity to kick HMRC’s tyres and see where the boundary lies. My message to these providers is be very careful, HMRC and HMT aren’t prepared to play around at the edges. Either you are laser-focused on growing your portfolio investee companies business or you risk rejection. There will be few grey areas.
So where does this leave Financial Planners?
The clear emphasis now for EIS and SEIS is on growth. Over the years, the EIS market has been dominated by capital preservation-type funds largely driven by adviser demand for investments that looked to mitigate as much of the risk of investing in small businesses as possible.
That supply line has now been choked off.
So financial planners now need to go back to their clients and reassess their attitude to risk. Are clients prepared to take a little more risk in return for the potential of significantly greater returns (still with the protection of income tax, capital gains tax and share loss relief if things do go wrong) or does EIS and SEIS now become too high risk? Many will also need to review their EIS and SEIS panels as we head into the tax year end period.
Putting my Chartered Financial Planner hat on, I have always felt that EIS and SEIS can play an important role within a client’s investment portfolio if used to help with diversification and this can go a long way to reducing some of the risk. An allocation of a client’s investment into EIS/SEIS not only provides tax reliefs but also gives exposure to some of the most exciting and innovative small businesses in the UK. This is exposure that cannot be garnered from traditional investment portfolios. EIS and SEIS give clients the opportunity to invest in businesses at the very earliest stages of their development, businesses that may well go on to become the “next big thing”. This is already happening with businesses such as Eve Sleep and Brew Dog, transforming traditional industry models and achieving market listings within only a few years of their inception. Both were EIS funded and have provided investors with healthy returns.
For too long EIS and SEIS have been viewed as a tax product with an investment element. The Budget changes send out a very loud message which turns that theory on its head. EIS and SEIS are investments for growth first and foremost with the added benefit of attractive tax reliefs. The emphasis has shifted and EISA will be working with financial planners in the run up to tax year end to help them and their clients understand this.
About Mark Brownridge
Mark has over twenty years’ experience in financial services. Prior to becoming Director General of the EIS Association, he was Head of Research and Development at Mazars, a leading UK financial planning firm. Mark is highly qualified, being a Certified Financial Planner, Chartered Financial Planner, Chartered Wealth Manager and Fellow of the Personal Finance Society. Also he previously sat on the CISI’s Accredited firms’ committee and TISA’s Distribution Policy Council. Mark’s involvement with EIS began 8 years ago and he has since championed EIS investing within a financial planning context. He is extremely passionate about promoting the industry, increasing its effectiveness and ensuring that EIS continues its 20 year success story in delivering £15BN of investment to over 24,000 small businesses.