UPDATE: As of the 15th March, Royal Assent on the Finance Bill has now been received, and the window to tax efficient schemes under EIS has now been closed. Read on for how this will affect entrepreneurs, IFAs and investors.
The Finance Bill first announced in the Autumn Budget has now passed through the House of Lords, and we are on track for Royal Assent to take place on the 15th March. The Bill contains sweeping changes for EIS, particularly concerning the tightening of regulations around EIS-based capital preservation schemes, which have significant interest from investors and advisors in recent years.
But as the Treasury taketh away, they also giveth – the total amount investable in a single ‘Knowledge Intensive’ firm under EIS is rising from £5 million to £10 million, and the total amount that an investor can claim rises from £1 million to £2 million per annum.
Looking past the current week-long grace period for investors to make their final wave of ‘lower risk’ EIS investments, what do these changes mean for IFAs, investors and entrepreneurs in the long term? We’ll look at each in turn:
Entrepreneurs are perhaps the most obvious beneficiaries of the new rules. By cracking down on capital preservation, the Government is aiming to redirect funds into genuine, entrepreneurial, growth-orientated start-up and scale-up companies. This should result in more investment in companies who are aiming to use the funds for growth. For ‘knowledge intensive’ companies, this upside is even more significant – as the amount of EIS investment they can receive both overall and per investor is much larger.
But the advantages for entrepreneurs don’t stop there. The Treasury has also committed to a 15-day turnaround for applications made under the Advanced Assurance mechanism, streamlining the process, ending delays and paving the way for more companies to receive EIS eligibility more quickly.
In addition, the rules regarding eligibility are changing. Entrepreneurs can now choose whether their firm’s 10-year eligibility for EIS is measured from the date of their first commercial sale, or the date from which their annual turnover first exceeds £200,000. Again, knowledge intensive firms stand to particularly benefit from this, with the latter measurement taking into account their often lengthy research and development cycles.
Those IFAs already knowledgeable in advising on scale-up investments are likely to benefit from increased interest in their services. Others, whose EIS recommendations were primarily focused on capital preservation in the past, might now be looking at the rule changes and wondering where to turn next.
But these advisers shouldn’t fear the changes. By diversifying investments and increasing transparency over where their clients’ funds will ultimately be placed, they will be able to continue to offer the same management of risk and reward that they have previously.
They won’t be alone. In fact, the approach of all IFAs take to engaging with clients on EIS is liable to evolve over the coming year, as an increased emphasis is placed on identifying investment opportunities tailored for a particular client’s needs.
Partly as a consequence, there’s also a likelihood of an increase in the diversity of many IFAs’ fund panels, and deeper due diligence into the funds within them – in many cases this will be aimed at ensuring they are investing in a sufficient number of technology/knowledge intensive firms.
It’s not inconceivable that this increased activity could result in an overall rise in EIS allocations among some IFAs. What’s more, there continues to be a large untapped market for EIS and SEIS investments. In 2016/2017, 32,700 individuals invested via EIS – yet the UK has over half a million individuals classified as High Net Worth. We believe that the new rule changes should only serve to enhance IFAs’ ability to access this market, and provide their clients with greater access to growth investments.
While investors will lose some of the most risk-averse investments, the doubling of the investment limit for knowledge intensive firms means that potential return – and commensurately, potential tax efficiency – is much greater. The Treasury estimates that a total of 4000 investors per year will benefit from this increase.
Similarly, the measurement of a company’s EIS maturity starting at its first £200,000 of turnover means that there is greater opportunity for follow-on investment, and again there is the potential for increased overall return as a consequence. This is likely to be more of an advantage for active investors – who will also stand to benefit from a growing choice of funds post March.
On the other side of the coin, those who are passive will need to make some adjustments to their investment strategy in order to maximise their benefit from EIS. Rather than concentrating investments in a smaller number of funds aimed at tax efficiency, they will instead need to increase their diversification in order to spread risk. The expected larger range of funds this year should will help both investors and their advisors with this process.
2018 could also be the year of SEIS. SEIS has always been higher risk than EIS – hence the higher amount of tax relief available, 50% – but the rules for it haven’t changed. As EIS gets pushed further up the risk/reward curve, it’s getting steadily closer to SEIS. Will investors trade the higher (perceived) risk for the promise of higher tax relief?
In a 2017 survey entitled “Effectiveness of tax incentives for venture capital and business angels to foster the investment of SMEs and start-ups”, undertaken by PWC on behalf of the EU Commission, 46 tax incentive schemes were observed across the EU and the US. Each was benchmarked according to principles of good practice – and EIS and SEIS were ranked numbers 1 and 2 respectively.
Both schemes continue to be highly effective for entrepreneurs, advisers and investors alike – at EISA we firmly believe that while capital preservation might cause short term inconvenience, it will have positive long term effects not only on the EIS industry, but the economy as a whole. We are wholeheartedly behind the strategy the Government is adopting for EIS and SEIS – the redirection of funds towards high growth, entrepreneurial startups and scale-ups promises to help the SMEs that sit at the heart of the UK economy.