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Lord Flight is Chairman of Flight & Partners Recovery Fund, and is a former Shadow Chief Secretary to the Treasury.

I have been Chairman of the Enterprise Investment Scheme Association (EISA) for the last ten years. EIS (and Seed EIS) provide tax incentives for high risk equity investment in start-ups and small and medium-sized enterprises (SMEs).

It was set up in the latter days of John Major’s Government and has since raised in excess of £15 billion of equity finance for both start-ups and SMEs. It has provided a major and important contribution to the huge success of entrepreneurship in the UK over the last decade.

What many do not appreciate is that it is not the job of banks to provide risk equity capital. But if new businesses have got the equity investment they need, they can then qualify for some element of bank finance.

HMRC commissioned its own independent research on EIS for the period up to April 2015 prior to the changes required by the EU, and this found that EIS was working as Parliament had intended.

A majority of the respondent SMEs viewed EIS as essential for securing equity investment, and 90 per cent of investee companies responded that their company had grown in terms of employee numbers since they first sought EIS or venture capital trust (VCT) equity support.

Ninety per cent of respondent companies attributed part of their growth in employee numbers to EIS and VCT investment. The medium growth in employment for SMEs since seeking venture capital investment was 33 per cent.

Greater awareness amongst politicians and government would be helpful; research by the Entrepreneurs Network found that less than 25 per cent of MPs knew about EIS.

A series of new regulations were imposed on EIS by the EU in 2015 which placed greater and more complex restrictions on business’s eligibility for EIS and SEIS funding and reduced the maximum funding which SMEs are able to raise under EIS.  These changes were unduly restrictive, and negative for the businesses which EIS was designed to help.

In particular the limitation of EIS funding to a particular business of £12 million on a lifetime basis, and the disqualification (with caveats) of businesses in existence for more than seven years, have imposed demanding historical research requirements which have complicated eligibility for EIS finance and added to the costs of establishing EIS eligibility.

Qualification for EIS financing has also been made more complicated by HMRC’s interpretation of the new rules; and by HMRC exemptions from some EU requirements, which were intended to be helpful but add further complexity.

The EISA has asked its members to raise these issues with their local MP, and to explain how important EIS has been as a source of funding for SMEs. We have also sent an open letter to Theresa May since she became Prime Minister, calling on her to remove the rules introduced in 2015.

The key point is that the limitations imposed on EIS by the EU, together with HMRC’s interpretation of the rules (and attempts to ameliorate them) have greatly complicated EIS qualifying requirements, both adding to the legal costs for modest start-up and SME equity raisings and delaying the time required for HMRC Advanced Assurance.

The issues which the EISA has been pressing to be addressed are many. Independent investor requirements are disenfranchising investors for EIS incentives who already hold shares in a company qualifying for EIS investment, unless such shares comprise part of the original subscriber shares or were part of a subsequent EIS issue:

Then there’s the sunset clause imposed by the EU requiring the ending of EIS in 2025; the reduction of EIS support to an historic total of £12 million – with a limit of £20 million for knowledge intensive companies; and the undefined requirement that EIS funds must be used for companies in their growth and development stage where there is a grey area between disallowed funding of losses and allowed funding of establishment costs.

It goes on: there’s the limiting of EIS qualifications to companies which have had commercial sales for less than seven years – here the complications are that this does not apply if the business is entering a new market, and the complexity of requirements to qualify as a knowledge intensive company, where applicants must commission an independent report as evidence they are knowledge intensive businesses.

Finally, EIS financing must not be used to finance buyouts or replacement capital where in several sectors, and in particular, precision engineering, there is a pressing need for finance to buy out the founders of such companies, as well as for the finance to take them forward.

The key problem produced by unwanted EU intervention and HMRC’s interpretation thereof is the creation of complexity for what is a small scale programme, requiring both expensive legal costs to avoid potential pitfalls and significantly delaying the time involved for HMRC Advanced Assurance.

In response to EISA and SME industry lobbying, HMRC has produced a consultation document on how the issue of time delays for Advanced Assurance might be addressed.  Unfortunately, this document does not address the fundamental cause of delay – unhelpful and unnecessary complexity, largely resulting from EU imposed requirements.

The HMRC, EIS/VCT Advanced Assurance System has become even more necessary than in the past as a result of these complexities and HMRC’s own interpretation of the requirements – so HMRC’s suggestion of ending Advanced Assurance would slash the volume of EIS investment as a result of the greater uncertainty this would create.

I was involved with the introduction of the Advanced Assurance regime, and one reason for itwas to enable HMRC to effectively “kill off” investment proposals which they viewed as “abusive”; but with the “quid pro quo” that achieving Advanced Assurance gave investors greater certainty that particular investments would qualify for EIS incentives.

The substantial increase in the timetable for achieving Advanced Assurance has led to some SMEs going bust whilst awaiting clearance for EIS funding.

There is a simple answer to the problem of Advanced Assurance taking too long: to remove the unnecessary complexities introduced by HMRC, on the back of the new EU requirements.

I detect, however, HMRC accepting the EU Trade Commissioner’s argument that high risk equity investment in start-ups and SMEs should not need tax incentives. I regard this as wrong because the UK is a much more oligopolistic market place than, for example, the USA.

It is difficult and expensive for new businesses in the UK to enter markets successfully. Without UK tax incentives SME investors would be wiser to invest in American SMEs where, in a much larger and less oligopolistic market place, market entry is easier.

The research which Alastair Ross Goobey undertook 20 years ago demonstrated that, without tax incentives for venture capital investment, listed equity investment had outperformed start up/SME investment; by and large this holds true today.  But, for the future, it is important and desirable to have a healthy market for equity investment in SMEs where the more there are, the greater is the prospect of creating successful companies for the future.

Moreover, as has been established, the cost of the tax incentives for EIS investment are covered by the several tax revenues they generate: corporate taxation; income tax on employees’ pay; both Employer and Employee NI; VAT on employee and employer spending; and savings in welfare expenditure as a result of the employment provided by EIS-qualifying SMEs.

Since EIS was introduced, the increase in entrepreneurial activity and the numbers of new companies established in the UK has been phenomenal – outranking the US on a scale basis – and the envy of Continental Europe. It would indeed be a tragedy if EIS is messed up under a Conservative Government.

Upon Philip Hammond’s appointment as Chancellor I wrote to him referring briefly to the fact that the EU impositions had messed around EIS. The message which has come to me from the industry is that they think HMRC would like to get rid of the programme.

My hope is that the Government will get a move on with alleviating the often unnecessary complexities of qualifying for EIS finance and make clear their support for EIS.

13 comments for: Howard Flight: Don’t wreck the Enterprise Investment Scheme

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