Schemes that have boosted innovative UK start-ups hit by changes to business property relief in strange case of shooting UK’s investment success story in the foot.
The UK’s Enterprise Investment Scheme (EIS) and its companion scheme, the Seed EIS, or SEIS, are the envy of the world. These vital schemes have channelled billions of pounds into early-stage and young innovative companies, helping to stimulate the national economy and the UK’s investment success story.
Since its inception in 1994, EIS has raised some £27bn for UK companies. The SEIS scheme, introduced in 2012, has raised more than £1.5bn. These are the UK Government’s own figures.
Together, the two schemes have helped to propel the UK into third position, behind the United States and China, when it comes to the UK’s investment story and having the largest number of successful innovative start-ups.
Unfortunately, changes the UK Government introduced to business property relief (BPR) as part of the drive to increase funds to the HM Treasury now look like becoming yet another instance where a short-term cash grab turns into a long-term disaster.
British farmers, it seems, are not the only ones getting hammered by the BPR changes. It looks as if the government has not only found a way of disrupting the handing-on of family farms, it has also managed to create a potentially serious disincentive to investment in these two highly successful schemes in UK’s investment story.
Ed Prior, Head of Investor Services at SFC Capital, which specialises in SEIS and EIS funds, explains why the BPR changes are so bad for these schemes.
“Many of our investors regularly maximise their annual £200,000 SEIS allowance. Currently, these shares are exempt from inheritance tax. However, under the proposed new BPR rules, beneficiaries would face a significant tax liability at the investor’s death, based on the company’s valuation at that time.
“Crucially, start-up investments are highly illiquid and cannot simply be sold to pay this tax bill. Beneficiaries would therefore be left facing an impossible situation: a substantial tax liability on an asset they cannot realise. As a result, larger and older investors, who form the backbone of this market, are already pulling back from investing to protect their beneficiaries,” Prior says.
This is because under the changed BPR rules any holding over £1m would crystalise a tax charge for the beneficiary. This charge would be based on whatever valuation was attributed to the shares at the time of the holder’s death.
“Inevitably, the inclusion of SEIS and EIS in the government’s proposed BPR changes risks severely undermining the success of these schemes. It will deter investment, reduce capital flows to start-ups and weaken the UK’s competitive edge in industries that are already defining the next generation of global wealth,” he argues.
Prior says that a more up-to-date figure for the combined impact of SEIS and EIS is that they have so far directed some £32bn into around 56,000 start-ups, driving job creation, technological breakthroughs and very significant long-term tax revenues.
Larger and older investors, who form the backbone of this market, are already pulling back from investing
James Paterson, a tax partner at BDO in Scotland, agrees that the proposed changes to IHT and business property relief rules will do nothing to increase the attractiveness of EIS or SEIS investments.
He too emphasises that EIS and SEIS shares are likely to be illiquid, so difficult to realise in order to pay a tax charge, and difficult to value given the investment may be in an early-stage loss-making business.
Prior points out that the UK Government has said that the valuation on death will be based on the last recorded funding valuation. “In start-up land, you can be valued at £20m at one point, and then go out of business six months later. So, an investor could be forced to pay a huge IHT bill on an asset which is worth zero just a few months later.”
However, Paterson argues that these types of investments tend to be used by investors at an earlier stage in their lives. “Some people may hold EIS shares as part of their estate planning, but I suspect more are invested in AIM-listed shares as these tend to be less risky than EIS/SEIS holdings in absolute terms – and obviously AIM investors have more to lose from the changes as the £1m allowance will not be available on deaths after April 2026,” he says.
Prior argues against the idea that many EIS investors are at an earlier stage in their lives. “Start-up founders receiving the investment tend to be at earlier stages in life. But the investor market is largely made up of people later into their life: at age 55-plus. That’s part of the reason these schemes are so good — because they help make the capital of those people productive for the future of UK PLC, by reinvesting into the next generation,” he says.
What frustrates Prior and others involved in advising investors and companies on EIS, is that the estimated IHT revenue that is likely to be raised from SEIS and EIS is unlikely to be more than £16m.
By way of contrast, EIS-backed companies alone generate an estimated £960m per year in corporate tax, VAT and employment tax revenues.
“This is an insignificant fiscal gain compared to the billions that are likely to be lost in long-term tax revenues if early-stage investment is weakened,” Prior points out. He argues that exempting SEIS and EIS from these charges would be a simple, pro-growth solution that would align well with the government’s economic priorities.
Daniel Hough, a financial planner with RBC Brewin Dolphin, says that while EIS/SEIS investments are an option for some of his clients, they are particularly attractive to investors with a high-risk appetite.
However, while individual EIS investments can be considered high risk, investors have the choice of either building their own diverse portfolio of EIS investments, or investing in an EIS fund.
Karen Davidson, a partner with Brodies’ corporate tax and incentives department, specialises in advising companies who are seeking to attract EIS and SEIS investments.
She argues that the qualifying rules set out by HMRC for these investments are so complicated that it is all too easy for companies to run afoul of the rules.
“Clearly, someone who invests significantly into what they think is an EIS-qualifying company will be hugely disappointed if that investment fails to qualify for the appropriate reliefs.
“One could really wish that the government would simplify some of the unnecessary complexities that are creating traps for the unwary,” she says.
“Fill in the wrong dates on the forms and you can find HMRC rejecting the investment. This is an area where companies really do need expert advice.”
In her Spring statement, the Chancellor Rachel Reeves said the government will continue to work with entrepreneurs and venture capital firms on how policy can support EIS and VCT schemes. She said roundtables will be held with key stakeholders throughout April.
