Relief from HMRC? The insight from our Leap 100 companies is revealing

Government intervention is not what most founders are typically looking for. But, in The Leap 100 April poll on corporate tax, respondents suggested they were either satisfied or very satisfied with tax provisions available to UK businesses.

That may come as a surprise, but the answer to the second question, “which relief is most important to your business?”, explains why. Overwhelmingly, respondents picked two reliefs critical to growing a business. These were R&D relief, which can either reduce tax bills for innovative companies or even generate a refund where startups are not yet tax paying, and relief for fundraising via initiatives like the EIS and SEIS.

What was revealing was the lack of emphasis on entrepreneurs’ relief (ER) and investors’ relief (IR).  This suggests that founders place a higher value on reliefs which enable businesses to grow, whether that is because of expenditure on R&D, or cash raised from further fundraising to facilitate expansion generally. Indeed, that might imply that, with capital gains tax being generally charged at 20 per cent, except for certain residential property and private equity investments, even for high rate taxpayers ER and IR are perceived to have less value. This sounds counterintuitive but if a founder manages to double the value of a business before exit, even after paying tax at normal rates on the increased sale proceeds, he or she is still better off. Following the government’s Patient Capital Review, it seems likely that the tax relief landscape may change.  Indeed, the Spring Statement provided some pointers.

First, for businesses where further fundraising rounds may dilute key employee shareholders below the five per cent threshold needed for ER, HMRC is considering whether to lock in lower tax rates on the growth that occurred up to the moment of dilution.  So rather than founders losing ER on the entire gain, they would preserve ER on the gain that accrued up to when dilution occurred. If this proposal becomes law, one perceived deterrent to founders seeking to grow a business should be removed.

Second, and consistent with founders’ interest in R&D relief, the government is considering whether EIS and SEIS relief might be available to individuals subscribing into a fund investing in knowledge intensive (KI) companies. That could enable would-be investors to rely on the fund managers, and by investing through a fund diversify their risk, rather than having to evaluate individual investments and hope that companies selected are “cherries” rather than “lemons”.

Increasingly questions are being asked about how targeted or how effective tax reliefs are in encouraging behaviour relative to their cost.

It is clear that the government wants to incentivise real risk taking and the development of KI businesses by the greater flexibility afforded under the VCT and EIS rules for such companies. So the tax incentives for founders will continue to develop almost as quickly as their businesses.

Gary Richards is a partner in the corporate tax department at Mishcon de Reya.