Government scraps replacement capital rules for VCTs and EIS

Philip Hammond 620px

The Government has decided not to go ahead with the introduction of increased flexibility for replacement capital within EIS and VCT schemes, the Autumn Statement revealed yesterday.

Within last year’s Autumn Statement paper, the Government said it would consider increasing elements of flexibility for replacement capital within venture capital schemes, and the move was welcomed by the industry as boosting small business funding.

Replacement capital rules involve the purchase of existing shares in a business when accompanied by a significant new investment into the business. EIS funding will continue to not be allowed to replace that capital.

The Treasury says: “The government will not be introducing flexibility for replacement capital within the tax-advantaged venture capital schemes at this time, and will review this over the longer term.”

A year ago, the news on replacement capital rules was welcomed by the EIS Association, which lobbied for the change, as it brings it in line with the EU.

Speaking to Fund Strategy, EIS Association director general Mark Brownridge says: “It’s disappointing as we supported the view that replacement capital would be a very useful tool for providing greater flexibility for companies, in terms of tidying up share registers and potentially allowing larger investors to come in, which would be supportive towards small companies looking to grow and develop.

“We didn’t believe its introduction would lead to any form of abuse but we understand that the Treasury has been intensively lobbied by some influential parties to scrap it as they believe it will lead to abuse and management buyouts via the back door.”

Last year, the Government banned VCTs from investing in management buyouts. VCTs previously avoided the ban by putting money raised prior to April 2012 into MBOs and then using money raised after that for non-MBO investments.

Wealth Club investment director Ben Yearsley says the move away from amending replacement capital rules is partly down to the fact that most of the VCTs managers have “moved on” from the banning of MBOs last year, which was “a massive thing to the VCT industry as most of the transactions were MBOs”.

He says: “All of the managers wanted amendments to things to help them go forward but in 12 months nothing has happened so they have adapted to this. They have launched other products to do MBOs rather than launching co-invest schemes or institutional funds that have no tax reliefs.

“I wonder whether HMRC have just thought there was no rush to amend the rules [on replacement capital] again and look at those later.”

Specialist tax consultant Philip Hare & Associates reckons any new legislation allowing replacement capital “is likely to be complex, and may require state aid approval.”

Hare says: “The ability to introduce this may be easier after Article 50 is triggered. Whilst the ability to use replacement capital to help businesses scale up is desirable, many may regard it as a lower priority compared with share conversions and improving the advance assurance process.”

The Government said yesterday it will “clarify” the EIS and SEIS rules for share conversion rights, for shares issued on or after 5 December in its Finance Bill 2017.

A share conversion can take place before a flotation or where share capital needs to be reorganised for a fund raising round. HMRC considers a conversion of shares to be a disposal of shares which can lead to a loss of the tax reliefs claimed.