Monday, 7 January 2019

New S/EIS 'Risk to Capital' rules make a mockery of investing in Start Ups

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The new rules brought in the 2018 Finance Act to prevent the abuse of S/EIS tax reliefs for SMEs and start ups, are completely unworkable. We now have evidence of one case where advanced assurance has been denied on the basis that the company's plans showed they aimed to give investors a return. 


Company X applied for advanced assurance (AA) under S/EIS tax reliefs for their current funding round. The company complied with all the standard criteria for these reliefs. However under the new 'risk to capital' criteria that came into force last year, HMRC has denied this company AA. The letter states - 

''The exit provisions provided in the supporting documents are indicative of an arrangement whereby investors will receive a return of their investment''  - thereby contradicting the new rules.

HMRC have made it very plain that this 'risk to capital' criteria must be met as a first hurdle before any other conditions are examined. So if your business shows your investors getting their money back then you will not be eligible. That's the law. 

'Risk to Capital' is 'defined' by the new rules as being the assurance that the risk of losing the investment is greater than the chances of it being returned. How you calculate these chances, which are based almost entirely on future events, is not discussed. What HMRC want people to invest in, are businesses that are more likely to fail than succeed. If you have one of these, then your investors will be eligible for tax relief. Makes perfect sense to us!

The full rules are here

The implication is stark. You cannot hope to get AA if you offer investors a business plan that shows at some stage in future, investors will get their money back. Note -  this is not a return on investment - it is merely the return of the principle sum. 

If we expand on this - companies now hoping to get AA on S/EIS schemes - roughly 100% of all companies using equity CF, then their plans must show that investors will most likely lose all of their money. That is so stupid as to be ridiculous. Who in their right mind seeks investment in a business knowing from the start that they will take that money and lose all of it. Then again, who invests using S/EIS reliefs knowing that they will certainly be making a lose.

There are many ways the Government could improve S/EIS but this isn't one. What we will now get - if this refusal is an indication of things to come, is companies creating a set of plans for HMRC and another set for investors. I do not believe I have ever seen a PD that assumes from the outset that all the investment will be lost.

We get this information to you as we have many contacts now in this sector and they are concerned as to the direction this is all going. When we launch ECFBuzz in July of this year - this sort of advice will be restricted to members - so why not join up now with a 50% discount here - 

8 comments:

  1. "the risk-to-capital condition may not be met if the wider circumstances of a case suggest that capital preservation is intended".

    Capital preservation is something I want to see! I do not want a company I invest in to loose all its capital!

    This wording is so bad it is yet another embarrassment to HMRC/DTI (or whatever they are called this week).

    I think the intention is to see that the SEIS/EIS funds are used/spent on developing, and hopefully growing, the business. Not sat in a bank account for 3 years and then redistributed. That would be a useful intention.

    What is not useful is that the wording is so bad that it allows the denial of SEIS/EIS to appropriate companies or that ridiculously risky business plans look more 'compliant' than safer ones.

    Thanks for the heads-up on this.
    Regards
    Hugh

    ReplyDelete
  2. And further on the criteria states:

    "Ownership or management structure
    One of the indicators of capital preservation activity is where the investee company’s investor base consists largely of individuals who are using a tax-advantaged scheme alongside the promoter and their associates, with little or no entrepreneurial involvement."

    Well by that standard that is all of the companies on Croudcube and Seedrs. Most of the companies on SyndicateRoom. Many of the companies on ShadowFoundr.

    This could be the end of equity crowd-funding. Perhaps that is the intent?

    Regards
    Hugh

    ReplyDelete
    Replies
    1. You are right - but it cannot be intentional as CC for example have implicit Gov backing - despite their atrocious record. As with most things Gov, it is incompetence.

      Delete
  3. And further...
    Example 1 puts at risk the Biotech spin-outs from university where the "angel syndicate, fund managers and other promoters have indeed been involved in setting up the company" that is exactly how university spin-outs work. The university provides very early stage nurturing and then retains a stake as the spin-out goes to ECF for the next phase; even retaining more that 'minority' shareholdings.
    Pertinax Pharma comes to mind.

    So it seems this is an intentional move to curtail ECF.
    Regards
    Hugh

    ReplyDelete
  4. And further,
    These new rules can be applied retrospectively. So you may end up at the exit 3, 5, 7 years down the line and HMRC may decide your investment never qualified for EIS.

    Disclaimer: "Advanced Assurance" contains no nuts, wheat protein and almost no assurance.
    Regards
    Hugh

    ReplyDelete
  5. Actually, it makes perfect sense to me.
    You are a rich person - a 45% payer
    You give my $avoidance EIS scheme 100k
    You get 30K back.
    Year 3
    Case 1 - The EIS Scheme puts 100% into a building soc acct
    you get 30K + 100K + interest.
    Case 2 - The EIS Scheme puts 50% into a building soc acct and the rest into EIS.
    They all fail.
    you get 30K + 50K + interest + a tax loss of (100-30-50-interest)*0.45 ~9

    ... so you could engineer that as a 50k investment into EIS with about a 10K downside.

    The trouble with rules and allowances is that some people game them.

    ReplyDelete
    Replies
    1. That is for an EIS scheme not for individuals investing in EIS AA companies on a their own. The Scheme or maybe scam system, needs addressing independently. As with all tax avoidence scam companies, they abuse the system to enrich their clients. Some people call them accountants.

      Delete