After their last report, there are few phrases entrepreneurs dread more than “Office of Tax Simplification release new report on capital gains tax.” But I suspect entrepreneurs may find a lot to agree with in the OTS’s latest report into simplifying practical, technical and administrative issues relating to capital gains tax.
Of particular interest are the recommendations to improve the administration of SEIS and EIS. It is an issue we have touched upon before. Advanced Assurance, a prerequisite for investment, is difficult to obtain from HMRC. Without professional advice, startups can get caught out by honest mistakes. Worse still, delays in the process can cause deals to fall through.
In our report, Unlocking Growth, we advocated a range of reforms to ensure the vital reliefs function properly.
The long waits could be better tolerated by SMEs if there was clear communication from HMRC on the application’s progress. Furthermore, HMRC should provide SMEs with clear feedback if an application for Advanced Assurance is rejected.
A number of measures could reduce delays and ensure more investment flows to innovative businesses. First, HMRC should work with investor organisations to produce pre-approved standard Articles of Association and Shareholders’ Agreements. Second, businesses using the pre-approved documentation could be fast-tracked. Third, if there was a mechanism to make corrections for ‘honest mistakes’ post-investment, it may enable lower-risk applicants to outsource the process to accredited advisors without fearing loss of relief due to filing paperwork incorrectly.
SEIS and EIS are significant tax breaks, so it is right that there are protections to prevent abuse and avoidance. But as the OTS quote one tax adviser, the rules can function like “elephant traps that seem more designed to help generate fees for advisers than to block misuse”.
There are few key changes the OTS proposes to make it easier for genuine entrepreneurs to access the relief.
First, under the status quo the application process is cumbersome and difficult to use. Some of the problems would be simple to fix. For instance, the OTS notes: “The application forms themselves are difficult to complete online as, although they can be completed on screen, there is no scope for saving partly completed forms.”
Less straightforward to fix, but clearly a problem is the fact that SEIS and EIS have similar information requirements, despite the former scheme being for businesses at an early-stage who are less able to afford professional advice.
Second, some modern commercial practices fall foul of the EIS regulations. We recently came across one innovative sharing economy start-up which had created a tech platform for parents to share and borrow children’s clothing. They were unable to access the relief as their business was considered to be a business that leased assets and therefore ‘low-risk’. However, the OTS is lighter on solutions here, noting:
“There is, however, a tension between what may appear to be restrictive requirements and the need to ensure that enterprise investment schemes are not being exploited”.
Third, a more tangible and easier to solve problem is excessive requirement for share issuances the day funds are received. The OTS point out that:
“shares in companies that qualify for enterprise investment schemes have to be issued when, or shortly after, any funds are received. If payment for the shares is even one day late, the whole investment is ineligible for tax relief.”
This can wreck deals and deter people from using the schemes – perhaps simply because of a timing delay within the banking system which is beyond investors’ control.” To resolve this problem, the report suggests a short grace period for start-ups.
Fourth, there are also problems with how the income tax and capital gains tax relief elements of EIS and SEIS function. Under the status quo, investors cannot utilise the scheme if they are unable to claim an income tax relief. However, this could happen because an investor has made a large income tax loss and has a negative income for the year. This is a problem because EIS and SEIS also provide capital gains tax relief.
To correct for this, the OTS suggest:
“The government ... explore whether Capital Gains Tax relief should still be accessible by the investor even when Income Tax relief has not been claimed. This would smooth out an odd outcome for taxpayers who have made Income Tax losses – which could be a particular issue in the current COVID-19 economic situation.”
Some of the changes proposed may be administratively difficult, but they would all help a tax relief that since 1994 has helped to raise over £22bn worth of investment into high growth businesses to help more startups. Let’s hope HM Treasury takes them seriously.