‘KNOWLEDGE INTENSIVE’ EIS: IS IT ALL LAB COATS AND TEST TUBES? Will Laws, Senior Marketing and Communications Manager at Oxford Capital, outlines what the government means by ‘knowledge intensive’ companies
For EIS investment managers, November’s Budget was the most nervously anticipated in years. Earlier in 2017, the government published its Patient Capital Review consultation, which revealed a concern that EIS was not channelling enough money to the right companies. Rumours were rife about what the Chancellor might do in response. Cut the rate of income tax relief? Increase the required holding period? Ban certain industries from participating?
of a company’s employees to hold postgraduate degrees in a subject that is relevant to their job and to be engaged in research and development activity. In practice it’s a rarity for companies to meet this strict test. Philip Hare, a tax consultant who specialises in advising companies raising or investing through the government’s venture capital schemes, says he has only ever come across two companies that met the skilled employees condition.
So what happened?
But thankfully companies can still qualify as knowledge intensive by satisfying a much broader ‘innovation’ condition. To meet this test, a company must be developing intellectual property which could reasonably be expected to form the backbone of the company’s business ten years from the investment. Scientific companies will often meet this condition, but so will companies that can show they are developing ideas or products that can be protected through trademarks, patents or other forms of IP protection.
As it turns out, the rumours of changes were not unfounded, as there have been some tweaks to the EIS rules. Indeed, unusually, the planned EIS changes were mentioned from the despatch box rather than being buried in the small print. But the changes are positive. Firstly, Chancellor Philip Hammond said he would “ensure that EIS is not used as a shelter for low-risk capital preservation schemes”. This has already been followed up with the publication of some HM Revenue & Customs (HMRC) guidance, designed to make sure EIS reliefs are only available when the investor’s capital is genuinely at risk. This renewed focus on risk-taking is to be welcomed, as is Hammond’s other big announcement regarding knowledge intensive companies. These companies already enjoy an enhanced EIS regime, including a lifetime funding limit of £20 million (compared to £12 million for other companies). Now, knowledge intensive companies can also raise up to £10 million of EIS funding (or a combination of EIS, VCT and other state-supported funding) in a year – a doubling of the previous limit. Furthermore, individuals will be able to invest up to £2 million in EIS companies in a given tax year, as long as at least £1 million of the total is invested in knowledge intensive companies.
What makes a company ‘knowledge intensive’? For some clients, the phrase ‘knowledge intensive company’ might intuitively mean university spinouts or engineering and life science businesses. And it is theoretically possible that such companies could meet HMRC’s ‘skilled employees’ condition, which forms part of the assessment of whether a company is knowledge intensive. This requires at least 20%
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GB Investment Magazine · February 2018
Furthermore, software including apps and website code can often be classed as intellectual property. This means innovative companies from a huge range of different industries could potentially be counted as ‘knowledge intensive’, because their businesses hinge on exploiting the IP that resides within their websites or apps. To qualify as knowledge intensive, companies must also have spent a certain proportion of their operating costs on research and development or innovation. Relevant expenditure should have been at least 10% of total operating costs in each of the three years prior to the EIS investment, or at least 15% in one of the three years. The detailed rules here are fiddly, but the upshot is simple. Companies can devote the vast majority of their operating costs to other activities and still meet the conditions for qualifying as knowledge intensive. This is an important point for clients to understand. It means that investing in knowledge intensive companies does not need to equate to participating in a funding round that will be entirely consumed by R&D expenditure. Investing in knowledge intensive companies could mean supporting commerciallyfocused businesses that will be using the funds raised to finance recruitment, sales and marketing, and other activities that could help grow the business and ultimately generate value for the investor.