Finance Bill

Lord Flight Excerpts

Monday 16th July 2012 Lords Chamber

[Lord Flight]

My Lords, I will say a little about small business and the EIS. The Minister stressed the importance of small businesses in his speech, and I think everybody across all shades of party opinion knows that small business can provide extra employment and boost the economy, and that the proportion of GDP and employment it represents continues to grow.

The EIS has been a considerable success and raised some £12 billion of high-risk equity for small businesses. It was interesting that the French Government sent a delegation over to the UK to look at why the EIS had worked so much better in the UK than the French scheme had in France, even though, on the face of it, the French scheme looked to be more generous. I also make the point that equity is just as important as debt—small businesses cannot, and should not, view bank borrowing as a substitute for equity. As a buffer for survival, equity is absolutely necessary.

At this point, I declare an interest, which is duly in the register, as chairman of the EIS Association, the not-for-profit trade body representing the various professionals involved in promoting and creating EIS offerings. My colleagues from the EIS Association have had an extremely constructive dialogue with HMRC and I pay tribute to the good will and constructive actions of particular individuals in trying to address some of the issues that need addressing, which the Finance Bill does to some extent. I was extremely pleased that the Government listened to the proposals to widen the coverage of the EIS and deal with the follow-on situation of small companies that had survived and grown a bit but needed some more equity capital. It was a pity that the Government were obliged to delay getting EU state aid clearance, as I do not see that these sorts of measures are any of the business of the EU. I am very pleased that the Government did listen and have addressed that.

I am therefore a little disappointed in respect of two big areas in the Finance Bill. The first is the limiting of loss relief to £50,000, or 25% of annual income, which changes the risk-reward nature of EIS investment. In a way, the Government have given with one hand, by widening the parameters, but taken back with the other hand with that measure. Given that small company investment is extremely high-risk, what the loss is going to be with small companies that fail is a material consideration. I know there is some amelioration of that in that losses can be spread over two years for tax purposes, but I feel that this was slightly a political measure and not really thought through in terms of its impact. For all those who invested under EISs in the past on the basis of loss relief, it is also retrospective in that it is being changed after they took the decision to invest based on the then risk/reward parameters.

A minor point is that the list of qualifying investments has been looked at from the negative side but not from the positive side. I cannot see why nursing homes and hotels are not qualifying investments. As the record shows, neither is an area where people make instant profits and both are socially useful. There is a case for reviewing the rules on a positive side.

The second point is perhaps the most material. The EISA has had constructive discussions with the Treasury for some time on measures to stop what I think we and the Government have viewed as abuse of the EIS, where the basic objectives, which we all understand, are being rather used for tax schemes and getting around the rules. Everybody in the industry broadly understands what those abuses are and is pretty constructive about dealing with them. This has led to the new rules in the Finance Bill that create Section 178A of the Income Tax Act 2007. It introduces new disqualifying arrangements which apply to VCTs and the new SEISs as well as EISs. These include test conditions A and B, and if either is met the arrangement is disqualified. I shall read condition A because I get very upset that the drafting of a law in this area can be so entirely opaque:

“Condition A … is that as a result of the money raised by the relevant issue being employed for the purpose of the relevant business activity, the whole or the majority of the amount raised is, in the course of the arrangements, paid to or for the benefit of a party or parties to the arrangements or a person or persons connected with such a party”.

I am afraid it is extremely opaque. I think I know what it is getting at: that where an EIS-qualifying company is to some extent fronting for a larger company that is underwriting its business risk, it is clearly not cricket. I wish that things such as that could be drafted in a way that is a little clearer and more straightforward.

The second condition, condition B, outlaws where a part of business venture, not otherwise qualifying, would qualify. For example, if, say, old people’s homes do not qualify, you separate out a restaurant in the old people’s home which would qualify. Candidly, I cannot particularly see the harm in that if it is employing people and providing a service. It would again be helpful if what the condition means were clear, but I question whether it is of much economic use.

The even bigger issue is that the new arrangements include a process for advanced assurance guidelines by HMRC. This is a form of pre-clearance. In the light of those very opaque conditions A and B, it is almost necessary in order for people to know whether an EIS proposition is okay. It is therefore helpful, but my first point is that it will require HMRC to be adequately resourced to provide and assess these pre-clearances. If not, there will be delays in the funding that small business badly needs.

I believe the initial draft of the Revenue’s guidance notes have, for some reason, been fairly widely circulated, which was not intended. As the notes stand, they are capable of being interpreted in an extremely unhelpful way. Most people know the issues that these guidelines are getting at but, on the face of it, the wording could unintentionally disqualify a range of businesses, especially developing, building, owning and operating solar, wind and other energy projects benefiting from ROCs. Typical characteristics of such investments are: that the majority of the investment comes from one or other EIS fund or VCT; where the business is a start-up; the customer servicing and maintenance function has to be outsourced initially because the business cannot afford to do it itself; and if there are any major engineering or other capital costs, they need to be outsourced to a third party until the business is large enough to be able to afford them. The guidelines include these four characteristics as disqualifying the business for an advanced clearance guideline under something called VCM21035. I cannot believe that it is the Government’s intention to disqualify, in particular, start-ups. It does not mean that these investments are automatically disqualified for EIS relief, but they are disqualified for this new advanced clearance. Of course, the new advanced clearance will, in practice, become an effective prerequisite in that no one is going to invest in an EIS proposition unless it has an advanced clearance under the new arrangements. The guidelines do not say, but could usefully do so, that—notwithstanding the specific guidelines—if the promoters believe the business is not abusive they should explain when they apply for advanced clearance. I think that is particularly relevant to the point I just made about start-up companies in the solar industry.

I also understand that the objectives of most of the fairly extensive clauses in the guidance notes go quite a lot further than what is in the Bill, which I do not think is necessarily intended. The guidance would be much more practical and helpful if it gave illustrations of the things that it seeks to disqualify. As the guidance stands, it would be much more practical for EIS funds to invest in follow-on situations and to avoid start-up seed capital. Again, this is entirely at odds with the objective of the new SEISs.

I hope the guidance notes will be reviewed and refined. At present, they will cause too much uncertainty and lead to a reduction in the flow of EIS funds to perfectly reasonable propositions. The essence of the point is that VCM21035 sets out where HMRC will decline to give advance assurance. At present, as I have just said, this is well beyond the new disqualifying principles within the Act. It also gives HMRC too much discretion to pick and choose whether or not companies get advance clearance. I am sure it is not the Government’s intention to disqualify start-ups from being largely funded by VCTs and EIS funds, nor to disqualify companies which in their early stage need a certain amount of outsourcing.

Finally, another issue that delays the flow of EIS funding is MiFID. Advisers need to be ever more protective if they are to promote EISs to their clients. It is not just a question of their clients signing to say they are a sophisticated investor; the adviser needs to write a paper saying why he considers the client to be a suitable investor for something as high-risk as the EIS. The bottom line is that, other than the most sophisticated advisers, most give up and say, “Well, we’re really not attached to this area. It is too difficult and too risky”. To the extent to which we can have any flexibility under MiFID, it is necessary to make it easier for intermediaries and financial advisers to be able to promote EIS investments.