News & Thoughts

MARKET UPDATE: SITR Draft legislation update

[updated 8th March 2017]

Here we provide further details of each aspect of the latest SITR legislation from leading SITR tax adviser, Neil Pearson.

This material is provided for information purposes only and are not intended to represent investment advice. Further advice should be sought before acting upon any information contained within this post.

Tax legislation changes regularly. The Chancellor (in his Autumn Statement on 23 November 2016) announced several changes to the SITR rules. On 27 January 2017, the Government published draft legislation that will form part of the Finance Bill 2017.

Following consultation and publication of the Spring Budget on 8th March 2017 there remain no further changes to the legislation.

The Finance Bill is due to be published on 20 March with the legislation likely to be enacted in July 2017. This will apply to investments made on or after 6 April 2017.

The changes are:

a) Increase the amount of investment a social enterprise may receive over its lifetime to £1.5 million, for social enterprises that receive their initial risk finance investment no later than 7 years after their first commercial sale – the current limit of €344,000 over a rolling 3-year period will continue to apply to older social enterprises

The Draft Finance Bill will introduce an additional qualifying condition for any social enterprise that wishes to raise material amounts of SITR funding. The change will mean that social enterprises may only raise SITR funding in excess of the current (relatively low) limit if they have been generating sales revenues for less than seven years. In other words, larger SITR fund-raises will be restricted to earlier stage (and therefore higher risk) businesses.

The Draft Finance Bill introduces a new lifetime cap of £1.5m per social enterprise.

In other words, the maximum SITR funding that a social enterprise can raise, when added to any VCT, EIS or SEIS funding, or any other “risk finance state aid” (“Relevant State Aid Funding”) cannot exceed £1.5m. Relevant State Aid Funding raised by any subsidiary, or by the former owners of any trade that has been acquired by the social enterprise, must be included within that £1.5m cap.

However, only earlier stage social enterprises (i.e. enterprises that have made their first “commercial sale” within the previous 7 years) will be eligible to take advantage of this increased cap for SITR. The only exception to this will be for “follow-on funding” i.e. if the social enterprise looking to raise SITR funding:

  • Has previously received Relevant State Aid Funding within that initial seven-year period, and
  • At least some of the Relevant State Aid Funding that was raised within that initial seven-year period was employed for the same trading activities that will benefit from the new SITR fund-raise.

The trading history of all group companies must be taken into account. So, for instance, a recently-established social enterprise that acquired a subsidiary that made a commercial sale more than seven years ago, would not meet this condition. Similarly, if a social enterprise has acquired a pre-existing trade from a third party, any sales made by that trade under its previous owners will be taken into account.

This “maximum age condition” has applied to EIS investments since late November 2015.

Social enterprises that made their first commercial sale more than 7 years ago, will remain eligible for SITR, but will be subject to the current rolling three-year limit of approximately £290,000 (see above). However even those social enterprises will be subject to an over-arching lifetime cap of £1.5m for all Relevant State Aid Funding.

b) Reduce the limit on full-time equivalent employees to below 250 employees

c) Exclude certain activities from qualifying for SITR

The Draft Finance Bill adds the following to the list of excluded activities that cannot be supported with SITR funding:

  • asset leasing
  • receiving royalties or licence fees
  • on-lending of monies
  • investment in nursing homes and residential care homes will be excluded initially although the Government has said that it intends to introduce an accreditation system to allow such trades to qualify for SITR funding in the future
  • any trade relating to the generation or export of electricity, or any other form of energy.

d) Exclude the use of money raised under the SITR to pay off existing loans

The Draft Finance Bill 2017 introduces a new requirement that SITR Monies cannot be used to pay off existing loans. In other words, SITR funding cannot be used to re-finance existing borrowings.

e) Clarify that individuals will be eligible to claim relief under the SITR only if they are independent from the social enterprise

The Draft Finance Bill will introduce a new restriction that individuals may only claim SITR if they are “independent from the social enterprise”. This will mean that an investor looking to make an SITR-qualifying investment into a social enterprise will only be able to claim SITR relief if, at the time the SITR investment is made, either:

  • They do not hold any existing investment in that social enterprise (and “investment” here would include a loan); or
  • They do hold an existing investment in that social enterprise, but all of their existing investments are either:
  • “permitted subscriber shares” (i.e. shares issued when the company was first incorporated and before that company had taken steps towards starting a trade), or
  • Investments in respect of which she has claimed EIS, Seed EIS or SITR relief.

f) Introduce a provision to exclude investments where arrangements are put in place with the main purpose of delivering a benefit to an individual or party connected to the social enterprise

The Draft Finance Bill 2017 will exclude investments which form part of a “disqualifying arrangement”. An arrangement is regarded as “disqualifying” if, as part of an SITR fund-raise, either:

  • All or a majority of the money raised is paid to or for the benefit of a third party that has some connection to the social enterprise, or
  • It is reasonable to assume that the trade carried on by the social enterprise would (in the absence of the SITR fund-raising arrangements) have been carried on by a third party that has some connection to the social enterprise

This is an anti-avoidance measure that is intended to catch what HMRC regard as “artificial” structures put in place with the sole or main intention of securing SITR funding for activities that would not (without the “artificial” element) have qualified for SITR. This measure has applied to EIS investments for a number of years and is now being extended to SITR for the first time.

To Note – The Draft Finance Bill 2017 introduces two additional ways in which SITR relief might be jeopardised. Both relate to the new £1.5m cap.

First, above we explained that the Draft Finance Bill 2017 introduces a new lifetime cap on all Relevant State Aid Funding (which includes SITR) of £1.5m. However, SITR relief can be lost if a social enterprise raises SITR funding but at any time within the following three years raises further Relevant State Aid Funding in excess of the £1.5m cap.

Secondly, we explained that if a social enterprise wishes to raise SITR in excess of the current lower limit (of approximately £290,000), it can only do so if it meets the “maximum age condition” i.e. it made its first commercial sale within the last seven years. However, SITR relief can be jeopardised if a social enterprise, having raised SITR funding in excess of the current lower limit, then:

  • acquires another company or trade that has been generating sales for more than seven years prior to the date of the SITR fund-raise, and
  • applies some of the SITR cash for the benefit of that newly acquired trade or subsidiary.

 To Note – Pre-investment: Advance Assurance

Any social enterprise can approach HMRC and ask for an advance assurance that a proposed investment will qualify for SITR. This is not compulsory. But it is often advisable, because:

  • It gives investors certainty that the tax relief will be available (so may help the fund-raising process as some investors may not invest without the advance assurance), and
  • HMRC will, in their response, flag up any feature of the investment that does not comply with the various criteria. This would, therefore, enable the social enterprise to make changes in order to conform with the legislation (in many cases it is not possible to put things right after the investment has been made).

The application for advance assurance must be in writing, and can be submitted by post or email. It can take HMRC anything up to eight weeks to respond.

As part of the Autumn Statement on 23 November 2016 HM Treasury launched a consultation on the future of the advance assurance system. The consultation documentation suggests that the existing system needs change, and puts forward a number of different models for the advance assurance process going forward. One of the proposals is that the process be scrapped altogether, leaving investors with no way in which they could be assured, in advance of making an investment, that HMRC would accept that the investment would meet all of the eligibility criteria for SITR. The consultation closed on 1 February 2017, so changes may be anticipated later in 2017.

To read the latest on the track record of SITR investments, click here.