The Autumn Budget was a bit of a disappointment for SMEs, but increases in the Enterprise Investment Scheme could be helpful for local high-technology companies.
New R&D expenditure credit rates won’t affect SMEs
By only focusing their increase in R&D relief on larger companies, ignoring the thousands of SMEs at the cutting edge of innovation, the government has focused on ‘Goliath’ and forgotten about ‘David’ in this autumn’s Budget.
With effect from 1 January 2018, the rate of relief for the R&D Expenditure Credit will increase from 11% to 12%. This is the scheme claimed principally by large companies, so the measure will not affect small or medium sized (SME) local companies (unless they have to use the large company scheme due to subsidised or grant funded R&D). While this is expected to help 4,000 companies across the UK, and is part of the government’s ambition to raise R&D investment to 2.4% of GDP, it ignores the thousands of SMEs that the government claims are vital to the growth of British economy.
At the same time, an advance clearance service will be launched so that companies can obtain certainty on their basis of claim before formally submitting (advance assurance is already available for SMEs).
It is unfortunate that the rate of relief for SMEs has not been increased – especially because the relief is linked to Corporation Tax, so with headline rates decreasing, the value of the tax relief to these companies is also decreasing.
Enterprise Investment Scheme (EIS) to be expanded
The government is increasing the amount of tax relief available to investors in small- and medium-sized high-risk private companies under the EIS scheme, where the company being invested in is classed as “knowledge-intensive”. This measure is designed to encourage greater investment in these small companies that are carrying out ground-breaking R&D into new technologies, which ultimately will feed into the wider UK supply chain.
Currently, an individual can obtain income tax relief worth up to £300,000 on a £1 million investment in any tax year, as well as securing Capital Gains Tax free status on the shares and the ability to defer other Capital Gains at the same time. The measure will increase this to a £2 million maximum, where anything over the £1 million existing limit must be invested in knowledge-intensive companies in order to qualify.
The company itself has an increased maximum investment of £10 million, which it can raise from investors under the scheme, as well as benefiting from relaxations to certain rules about the age of the company.
This is a positive change for small high-technology companies looking to make themselves a more attractive investment proposition for private investors. There was much talk before the Budget about a potential attack on the EIS scheme as it is seen by some within the Treasury as a mechanism for wealthy individuals to avoid paying tax, so it is a relief to see that this vital scheme has been preserved in the main.
Enterprise Investment Scheme’s low risk investments
For some years, there have been providers who have been able to offer EIS qualifying ‘funds’. These are carefully structured in such a way that EIS qualification is obtained, but there is actually no risk to the investor of losing any of the invested money. Some of these funds have guaranteed returns of almost 100% – so with the benefit of the 30% tax relief, it is virtually impossible for the investor to lose money.
The government has recognised that these funds go against the principles of EIS, which is to encourage investment in small, high-risk businesses, instead using the scheme as a tax avoidance tool. For this reason, they are introducing an additional qualifying condition concerned with the amount of ‘risk to capital’ inherent in the investment.
This will require companies and providers to carefully consider whether the risk is sufficient before making an application, because it is only after the investment is made that HMRC will decide whether to approve an investment for EIS status. In some cases, Advance Assurance will have been sought from HMRC and this will stand, but HMRC will cease giving Advance Assurance to such cases from the date when they publish their draft guidance on the rule changes.
It is pleasing to see that the Treasury has taken the approach of targeting specific abuse of the scheme, rather than making a wholesale reduction to the relief which would have affected genuine investors risking their capital in the interest of helping small innovative businesses to grow and develop.
Indexation allowance being phased out
Indexation allowance, a relief against tax on gains on disposals of properties or shares, was frozen for individuals and trusts as long ago as 1998, and then abolished totally in 2008. However, the allowance has remained available for limited companies. Where a company has owned assets from as long ago as 1982, this allowance can now more than treble the “base cost” used to compute the taxable gain on a disposal.
This ‘anomaly’ will now be removed, meaning that indexation of assets within limited companies will be frozen with effect from January 2018. We suspect it will be abolished after a few years in the same way.
For companies with significant capital assets that they have owned for many years, owners now need to carefully consider their long-term strategy for those assets – there is no rush to sell them quickly, but with the prospect of abolition in the future, the tax impact could be very significant. For example, a property worth £100,000 in 1982 being sold today by a limited company for £300,000 would result in zero tax, but without indexation allowance the tax liability would be £38,000.
It is likely that this is yet another measure to discourage landlords from incorporating their rental property businesses to escape the interest relief restrictions and to take advantage of the relief from indexation afforded by a corporate structure.