17 May 2006
Ceri Smith
Head of Directorate Standing Team
SME Taxation, Budget & Public Finances Directorates
HM Treasury
1 Horse Guards
London SW1A 2HQ
Dear Ceri
VCT Budget changes
As you will recall the BVCA welcomed the Chancellor’s continued support for VCTs in the Budget in terms of the tax regime, in particular the commitment of the Chief Secretary in the House of Commons to maintain the 30% tax rate for the duration of this Parliament. We understand too why other changes, including those to Gross Assets, were introduced. We also noted very positively the commitment made by the Financial Secretary to the Treasury during House of Commons debate to keep a watching brief on the development of the industry and any detrimental impact of the proposed changes, as we believe this is in the interests of the longer term role the VCT industry can play in the “Bridging the Finance Gap” agenda.
After due consultation over recent weeks we are aware that the significant majority of VCT managers have longer term concerns about the possible impact of the changes, but the purpose of this letter is to highlight certain aspects of the revised proposals where changes or clarification will (a) assist our members comply with the proposed legislation and (b) mitigate potentially unfair consequences for VCT shareholders.
We believe the solutions we suggest below fit within stated policy objectives regarding the targeting of VCT funds to the earlier stage and higher risk end of the investment market and for this reason urge you to give due consideration to them, and in particular whether any legislative or other Treasury action is needed, prior to release of final legislation within the 2006 Finance Act.
The proposed change to the definition of “Investments”, leading to the discontinued availability (from 6 April 2007) of non interest bearing accounts (“NIBAs”) to manage temporary difficulties in meeting the VCT tests.
We believe that the general view amongst most VCT managers is that the introduction of a practical alternative solution to the use of NIBAs is welcomed. Clearly the use of such accounts can have a detrimental impact on performance and shareholder interests, so in the long term an alternative is desirable to all parties.
However, there are practical difficulties around the sudden change to what has been part of established practice to date (the new rules on NIBAs were announced on 22 March 2006 by which time over £1,000 million had been raised since 5 April 2004 in the belief - on the part of managers and shareholders - that temporary problems could be resolved by using NIBAs).
Managing realisations
For a VCT that has already met the required investment levels, there is a need to be able to make sensible commercial decisions on realisations of successful investments. Without the safety valve that the short-term use of NIBAs offers, these realisations could trigger a breach of the VCT rules. Again we welcome comments made by the Financial Secretary to the Treasury in Commons debate confirming that guidance is to be released regarding the use of the “inadvertent breach” provisions to cover such situations. We would urge however that:
input is sought from VCT managers and/or their representatives and advisers during the process of drafting relevant guidance;
the guidance moves away from the term “inadvertent” breach to cover other potential breaches including realisations which result from sensible commercial decisions being made by the managers in the best interests of both VCT shareholders and the investee companies;
the guidance introduces an “advance agreement” process, rather than the current requirement for a breach to have been made before approaching HMRC for confirmation that it will be “inadvertent” and to agree steps and timing for rectification;
the “advance agreement” guidance takes into account in rectifying the situation the specific circumstances of each VCT, including its ability to make (and timing of) capital distributions and its normal investment (reinvestment) cycle;
similar provisions are available within the guidance for VCTs still within their “three year” period, where they are on target to invest at least 70% of net funds raised but may not be able to reinvest realisation proceeds quickly enough for the total investments to meet the 70% test by the end of the required period;
provision is made in the forthcoming Finance Act, or other formal written statement, for the introduction of such guidance. This will give VCT Boards the assurance they need that HMRC will have the necessary power to deal with advance agreements
Clarification of the three year investment rule
We note that VCTs, depending on their accounting period dates, can have significantly less than three years in which to meet the required investment levels. It would be more equitable for the three year period to run from the date of each allotment of shares, but clearly this is impractical administratively. As the new definition of “investments” is introduced, we therefore suggest as a more practical alternative that funds raised in the 2004/05 and 2005/6 tax years (a large proportion of which were raised in the months of March 2005 and March 2006) should be required to meet the investment tests by 5 April 2008 and 2009 respectively. This would mean that there is a full 3 year period to invest the new funds.
Definition of “Gross Assets” in relation to internally generated intangibles
The current definition includes all assets on the balance sheet. This is an imperfect measure, although it is understood that to have a more precise test is likely to involve many pages of legislation.
It is widely believed in the VCT industry that through the introduction of International Financial Reporting Standards (IFRS) companies which otherwise meet the policy objective for VCT investment could find that funding opportunities are reduced or eliminated where they are required to capitalise their costs on the balance sheet. This includes R&D costs, capitalised staff costs, goodwill etc. We therefore propose that capitalised costs incurred by the investee company should be excluded from the calculation.
We understand that in legislation dealing with R&D tax credits the distinction between capital and revenue expenditure has been removed specifically to deal with the impact of IFRS.
We do believe that the gross asset test “parameters” need to be closely monitored to ensure the limits both meet Government policy and allow sensible commercial investments which will lead to continuing support from private investors as a source of funds.
Investment intention
This letter is intended as a reflection of the immediate concerns of the significant majority of VCT managers, whose views have been canvassed through survey and attendance at a discussion forum earlier this month. It is the genuine intent of VCT managers that they meet the commitments made in their prospectuses and attain the required level of investment within the necessary timescale. However, there may well be unforeseen circumstances which could impact upon this. Most commentators would say that market conditions are currently strong but that could change. We do not believe that it can be in the interests of Treasury policy for managers to make “unnatural” investment decisions, perhaps paying inflated prices for investments purely in order to meet the tests.
We appreciate that you are endeavouring to remove any general “let-out” from reaching the required investment levels (albeit as noted above the detrimental impact NIBAs can have on performance should naturally mean that managers would not want to use them as a “soft” option). However, there is valid concern in the industry about there being no “safety valve” at all and the impact that could have on investment behaviour.
It is also felt that the entire removal of a VCT’s qualifying status, in cases where best endeavours have been made but required investment levels have not in the event been able to be achieved, is disproportionate in its impact on VCT shareholders.
Yours sincerely
Jeremy Hand
Chairman, BVCA Taxation Committee
