HMRC has included draft guidance in their Venture Capital Manual of how the new “Risk to Capital” conditions should be reviewed. These new rules were introduced in the Finance Bill 2017-18, in order to ensure that EIS and VCT relief is only available to companies which are expected to grow, and where there is a genuine risk to investors of losing their capital. However, there are still legislative uncertainties on how these can be interpreted.
The Risk to Capital conditions are broken down into two parts where both need to be met if the investment is to be qualifying: –
a) The company in which the investment is made must have objectives to grow and develop over the long term; and
b) The investment must carry a significant risk that the investor will lose more capital than they gain as a return (including any tax relief)
The draft HMRC guidance suggests that Condition a) will be evaluated by taking revenue, customer base and number of employees. However, what does this mean in practice?
If broken down, growth and development do not seem to be defined in the legislation; however, this appears to be what the EIS legislation was previously prescribing – ‘to raise money for the purposes of a qualifying business activity so as to promote growth and development’ (s.174 ITA2007). Emphasising on long-term on the other hand indicates that any immediate plans of growth may not necessarily satisfy the condition above.
Condition b) seems to be placed to ensure that the amount the investor puts at risk of loss must exceed all returns that are likely at the time of making the investment. HMRC evaluates the risk of loss by determining:
- The risk of losing the money invested; and
- The likely net investment return for the investors to whom the shares or securities in the company were issued.
Moreover, HMRC’s draft guidance stresses that the risk referred to above is the commercial risk of the company failing in the market.
Although Finance Bill 2017-18 has not yet received Royal Assent, HMRC inspectors have started applying the new rules in practice in respect of advance assurance applications – the rules therefore are worth keeping in mind.
If you would like to discuss anything mentioned, please contact a member of the Tax team.