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Summer Budget 2015: VCT and EIS changes

New rules will prevent VCTs from investing in MBOs.
July 9, 2015

Venture capital trusts (VCTs) will no longer be able to invest in management buy-outs (MBOs) under rules announced by HM Treasury. Although these funds have not been able to put qualifying money raised after April 2012 into MBOs, VCTs have been able to invest non-qualifying money - 30 per cent of what they raise - into this kind of investment.

VCTs have also got round the ban on investing in MBOs by putting money raised prior to April 2012 into MBOs, and using money raised after that for non-MBO investments, running expenses and dividend payments. And when a VCT exits an MBO investment, the money from that has been able to be invested into another MBO.

Under the new rules, this will be no longer possible. This will take effect from the time of Royal Assent to the Summer Finance Bill 2015, expected to be in September or October. Further details on the rules will be published next week.

MBO investments have been made by generalist VCTs including the Maven, Mobeus, Northern, Baronsmead and British Smaller Companies funds.

Bill Nixon, managing partner at Maven Capital Partners, says if there is no change to this rule it is likely that VCTs will raise less going ahead because their choice of investments will be more restricted.

"In terms of their current investment strategies, this will have little or no impact for some VCTs, but for those previously focused on MBO-type investments this will mean quite a change, and it will be interesting to see what impact this has on VCT fund-raising plans this tax year, potentially adding to existing concerns over limited supply," adds Philip Rhoden, director at discount broker ClubFinance.

"Potentially lower fund raising activity due to a narrower set of investment opportunities ironically comes at a time when potential demand for VCTs from investors might otherwise have been stronger than ever as a result of the reductions in the lifetime pension allowance and the tapering away of pension tax allowances for higher earners, confirmed in the Budget today," adds Jason Hollands, managing director at Tilney Bestinvest.

VCTs, Enterprise Investment Schemes (EIS) and Seed EIS (SEIS) will also not be able to invest in companies seven years or older after their first commercial sale took place, and 10 years or older for knowledge intensive companies.

This is stricter than what the government announced in the March budget – that VCTs, EIS and SEIS couldn't invest in a company more than 12 years old. However, the rule will not apply where the total investment represents more than 50 per cent of the company's turnover over the preceding five years.

Mr Nixon argues that this is an unnecessary limitation to what VCT managers can do.

There will also be a cap on the total risk finance a company can receive from VCTs, EIS and SEIS of £12m – lower than the £15m suggested in the March budget.

However, for a knowledge intensive company this is £20m.

The government says that the higher limits for knowledge intensive companies will support hi-tech and innovative firms. Knowledge intensive companies eligible for funding from VCTs, EIS and SEIS will also be able to employ up to 500 people, unlike 250 for other companies. This is a slight change on the 499 limit announced for knowledge intensive companies in the March budget.

David Hall, managing director of YFM Equity Partners which run the British Smaller Companies VCTs says that while any change that is more restrictive will have an impact, a lot of the sort of business their and other VCTs tend to target do a high level of research and development so may qualify as knowledge intensive companies.

The government is also launching a stake holder forum to discuss operation and use of VCTs, EIS and SEIS. The forum will be made up of HM Revenue & Customs, the Treasury and 30 industry representatives including users of the schemes, tax advisers, accountants and law societies.

Its discussions will be on topics including the development of a standard format for annual VCT returns.

The first forum will take place on 21 September.

Knowledge intensive companies

The government has set out what it defines as a knowledge intensive company. To qualify a company must have relatively high research and development or innovation spend of either:

(i) at least 15 per cent of total operating costs in at least one of the company's 12 month accounting periods ending in the three years preceding the accounting period in which the investment is made; or

(ii) at least 10 per cent of total operating costs per year in each of the accounting periods ending in the three years preceding investment.

The company must also meet one of the following criteria relating to the skills and ambition of the company defined as:

(i) requiring highly skilled staff to carry out the innovative activity – at least 20 per cent workforce with higher education qualifications (masters or above, or equivalent); or

(ii) intending to innovate or develop new patents where the exploitation of these innovations will represent the greater part of its business activity within the next 10 years.