I am concerned that HMRC are interpreting the EU rules in a very restrictive way to prevent companies which have been trading for more than 7 years grouping several new product investments together to meet the 50% annual turnover threshold. This interpretation is emerging without any proper debate or consultation and is somewhat perplexing given that there is no EU rule which prevents companies from grouping several investments to meet the 50% annual turnover threshold. The implementing rule in Finance (No.2) Act 2015 section 175 A (1) and (4) of the Income Tax Act 2007 does not require any such restriction either.

Consider the hypothetical example of a biotechnology company, which has been trading for more than 7 years, and suddenly discovers a cure for both brain cancer and a cure for liver cancer. Imagine that the amount of capital it requires to pursue both cures will exceed 50% of its historic turnover although the expenditure on each business activity will not. Imagine too another aged biotechnology company has also been hard at work and has also discovered a cure for brain cancer and, similarly, the expenditure it requires also exceeds 50% of its historic turnover. It seems that HMRC would currently argue that the second company is eligible to raise EIS finance but that the first company, having discovered two cancer cures rather than only one, is not. I cannot conceive of a more ridiculous outcome.

The announcement in the Financial Times on 12th May 2016 that three Oxford biotechnology spin out companies have raised £37 million was tremendous news. It would be a huge mistake if this distinctly odd interpretation of EU rules by HMRC were to put the brakes on EIS investment in new technologies.

At a time when British manufacturing and engineering jobs are under threat, as evidenced by the current situation at Port Talbot, the launch of multiple new business products by and the expansion of growing British companies that will help create multiple new jobs should be supported by a proper HMT/HMRC interpretation of EU rules and not thwarted by unnecessary gold plating.

Technical Argument

The EU rules are contained in Article 21 of The General Block Exemption Regulation adopted (GBER) as applied to the EIS by the Guidelines on State aid to promote risk finance investments.

Article 21 .5 provides as follows:

“Eligible undertakings shall be undertakings which at the time of the initial risk finance investment are unlisted SMEs and fulfil at least one of the following conditions:

• (a) they have not been operating in any market;
• (b) they have been operating in any market for less than 7 years following their first commercial sale;
• (c) they require an initial risk investment which, based on a business plan prepared in view of entering a new product or geographical market, is higher than 50% of their average annual turnover in the preceding 5 years”.

Article 21.5(c) is the relevant rule which concerns us

The European Commission has published a document called “General Block Exemption Regulation (GBER) Frequently Asked Questions [Date of publication Q&A to Articles 1 to 35: July 2015, Q&A to Articles 36 to 58: March 2016] (GBER FAQs). The GBER FAQS do not raise any frequently asked questions and answers with regard to Article 21.5(c) and therefore we must interpret this rule as it stands.

The words in Article 21.5(c) ‘based on a business plan prepared in view of entering a new product or geographical market’ are general and not precise in nature and remain true whether a business plan contemplates one new product or geographical market or a collection. An initial risk investment which is ‘based on’ a business which is ‘prepared with a view of ‘entering one new product or geographical market could encompass a plan which has a primary focus on one market but which also has a subsidiary focus on other markets.

This EU rule is reflected in UK legislation in section 175 A (1) and (4) of the Income Tax Act 2007 as follows:

• “(1) The requirement of this section is that, if the relevant shares are issued after the initial investing period [the period of 7 years beginning with the relevant first commercial sale] condition A, B or C must be met.”

and

“(4) Condition B is that-

• (a) the total amount of relevant investments made in the issuing company in a period of 30 consecutive days which includes the issue date is at least 50% of the average turnover amount; and
• (b) the money raised by those investments is employed for the purposes of entering a new product or geographical market.”

Sub-section (a) uses the word “total” in referring to the aggregate amount of the investments which must exceed 50% of the average turnover amount.

In contrast sub-section (b) merely refers to “the money raised by those investments” being employed in the prescribed way, ­ the word “total” is not used.

There is simply no requirement to use “all the money” and the natural meaning in sub-section (b) of the words “those investments”, using the plural, means that the money raised by each investment made in a period of 30 consecutive days can be applied for the purpose of entering a different new product or geographical market; although the money raised by any single investment would need to be employed on only one product or geographical market.

This last part of sub-section (b) may indicate an original ambition on the part of HMRC to gold plate the underlying EU rule, because I would accept that it makes no sense to restrict the amount raised by a single investment to employment on one market if, overall, the total amount of investments made in the 30 day period can be invested in several markets, but in imputing the intention of Parliament we should have regard only to what Article 21.5(c) of the GBER requires. The words used in the GBER do not dictate that an eligible undertaking should only be allowed one business objective in its business plan, merely that its risk finance investment should be based on a business plan prepared with a view to entering a new product or geographical market and the GBER certainly does not preclude the possibility that the undertaking might have other business objectives. Fortuitously, the UK legislation doesn’t require anything different but HMRC have now produced their draft guidance on this new rule in which they say:

“Each new business activity must satisfy the 50% turnover test. A number of smaller unconnected initiatives cannot be combined in order to meet the 50% threshold”

There is no concept of separate business activities either in the EU rule or in the implementing UK legislation.

Accordingly, in my humble opinion, the HMRC interpretation of the law and their guidance on this point is erroneous.

Roger Blears