UK: Tax Reliefs For Sustainable Technology Companies

Introduction

This briefing note highlights some recently introduced and updated tax reliefs currently available to new and existing businesses using a corporate structure which may be relevant to growing and entrepreneurial businesses. It is not an exhaustive list and does not cover all circumstances. For a full discussion and advice concerning tax matters affecting your business, please get in touch with your usual Smith & Williamson contact or one of those shown on our website (the link appears at the end of this briefing note).

Enterprise Investment Scheme (EIS)

EISs are becoming increasingly popular for businesses in the sustainable technology sector as a way of attracting finance. EIS seeks to encourage equity investment in qualifying companies by individuals by providing those individuals with tax reliefs. Some of the benefits for investors are as follows:

• Income tax relief of up to 30% on the amount invested in qualifying investments of up to £1,000,000 per tax year per person.
• If an investor holds EIS shares for at least three years (or for at least three years from when the company starts trading if later), upon disposal any gain arising would be exempt from capital gains tax, provided EIS income tax relief has been given and not withdrawn.
• For UK resident investors, gains on disposals of any asset can be deferred by reinvesting the gain into qualifying shares in EIS companies. The amount of gain that can be deferred is not limited by the amount of income tax relief on investment.
• Losses suffered on the disposal of EIS shares (in excess of any income tax relief given and not withdrawn) can be relieved against other capital gains or income.
• EIS investments also qualify for 100% inheritance tax relief, once the shares have been held for two years.

There is a limit on the level of funds that can be raised by a company through the EIS and Venture Capital Trust (VCT) schemes. This limit is £5 million in any 12 month period (applying from 6 April 2012), and investments from either of these schemes must fall within the aggregate limit.

There are a number of conditions that a company must meet in order to qualify for EIS relief, in particular it:

• must be an unquoted trading company at the time the shares are issued;
• must issue new eligible shares for cash, fully paid up at the time of issue;
• must not be a 51% subsidiary or be under the control of another company;
• must be "small". This means that, at the time of the new share issue, it must have fewer than 250 full-time employees and the gross assets of the company (or of the whole group if it is the parent of a group) cannot exceed £15 million immediately before any share issue and £16 million immediately after that issue.
• must exist for genuine commercial reasons, and not be part of a scheme for the avoidance of tax.

Seed EIS (SEIS)

The government has introduced a new SEIS scheme for shares issued after 5 April 2012 to encourage investment into early stage businesses. In order to qualify for the relief, a company must be undertaking or planning to undertake a new business (less than two years old at the date of share issue). The company or group must also have fewer than 25 full-time employees and gross assets of less than £200,000 at the time of the SEIS investment.

Qualifying companies will be able to raise up to £150,000 under the scheme in any three year period, and funds raised must be used within three years. Once 70% of the funds have been used, the company may raise funds under EIS or from VCTs.

The maximum that an individual can invest under SEIS is £100,000 per tax year.

The benefits of the scheme for investors include:

• upfront income tax relief of 50% for subscriptions of shares by investors (which can include directors) of up to £100,000 per tax year;
• no capital gains tax payable on the disposal of SEIS shares which have been held for more than three years;
• an exemption from capital gains tax on gains realised from disposals of other assets made in the 2012/13 tax year, where the gains are reinvested through the new SEIS in the same tax year (or in 2013/14 if a back-dating election is made) and the SEIS shares are held for the full three years.

Research & Development Tax reliefs

R&D occurs, for tax purposes, when a project consists of creative or innovative work in the field of science and technology, and is available to all companies (there is no minimum expenditure requirement for accounting periods ending on or after 1 April 2012).

Currently there are two schemes for R&D tax relief in the UK, depending on the size of the company.

Small and medium sized entities (SMEs)

A company qualifies as a small or medium sized entity (SME) for the purpose of the R&D regime if it has less than 500 employees and either turnover is less than or equal to €100 million or the balance sheet total is less than or equal to €86 million. This is an annual test.

SMEs can claim a 225% tax deduction for qualifying expenditure relating to qualifying activities for expenditure incurred on or after 1 April 2012. Loss-making SMEs may also be eligible to claim a repayable tax credit, limited to a percentage of the unrelieved losses attributable to R&D relief. This can be up to 25% of the qualifying R&D cost, even where no corporation tax (nor PAYE/NIC for periods ending on or after 1 April 2012) has been paid.

Large companies

Large companies are those that do not qualify as an SME. Large companies are entitled to a 130% deduction on all qualifying expenditure incurred on or after 31 March 2008. There is currently no payable tax credit available for large companies, although consideration is being given to the introduction of a repayable tax credit from April 2013.

Many companies miss out on tax relief by failing to claim R&D tax credits or relief. This may be because their R&D activities are integral to, or in support of, their overall trade and not something they specifically identify as being R&D, e.g. software development. However, upon investigation, these activities will often qualify for relief.

Qualifying expenditure

R&D relief at the enhanced rate only applies to certain revenue expenditure - generally, costs incurred in the day-to-day running of the R&D project, as opposed to money spent on capital assets. So you can't claim this relief on any capital expenditure for the R&D project, though it may be possible to claim for qualifying revenue expenditure capitalised as certain fixed or intangible assets. However, you may alternatively be able to claim relief for capital expenditure on R&D as a 100% capital allowance known as 'Research and Development Allowance' (RDA).

Patent Box regime

This will provide an additional incentive for companies to commercialise existing patents and to develop new innovative patented products.

Benefits

From 1 April 2013, companies will be able to elect to phase in a reduced rate of corporation tax to profits generated from qualifying patents and limited other forms of intellectual property (IP). The reduced rate is 10% (expected to be lower for small companies) which will be staggered in from 2013, and fully effective from April 2017.

Qualification

The new rules apply to new as well as existing patents granted from the UK Intellectual Property Office (IPO), the European Patent Office (EPO), and patent offices of certain individual EEA countries. Certain other IP rights can also qualify. If you own, or have an exclusive licence in the patent, then that licence should also qualify. Certain conditions regarding development and active management have to be met.

Income from the following sources is treated as qualifying:

• patent licensing and royalties
• sales income from the patent or patent protected products even if the patent only applies to a small part of the total product
• patents used in processes or services
• patent right damages for infringement.

There is a formula to assess the IP profits chargeable to the reduced rate of corporation tax, and amongst other things this will exclude the effect of enhanced R&D relief, finance income and expenses, the profit attributable to marketing and brands and a standard mark-up to take account of a 'routine return'.

It can be complex to capture the data to perform the required calculations, though the calculations can be simplified for companies with smaller profits. In view of the short time to its introduction it may be appropriate to review how qualifying IP is held within your business and the capability of systems and procedures for capturing the required data.

First year allowances on certain capital expenditure

Businesses can claim first year allowances (FYAs) on certain types of plant and machinery. FYAs allow the business to claim up to 100% of the expenditure incurred. However there are some exclusions, for example for expenditure on long life assets and expenditure on plant or machinery for leasing. An exclusion from FYAs for expenditure incurred on or after 1 April 2012 applies to plant or machinery used for schemes that generate electricity subject to a feed in tariff arrangement (an exclusion also applies from 1 April 2014 for expenditure on plant or machinery qualifying for renewable heat incentives). In contrast to the 100% allowance permitted for the annual investment allowance, there is no limit on expenditure qualifying for FYAs.

Where expenditure is incurred on certain energy or environmentally beneficial plant & machinery qualifying as FYA, there is the opportunity to surrender losses generated by the allowances in return for a tax repayment. Energy and environmentally beneficial allowances are known as ECAs. Qualifying expenditure for ECAs is restricted to assets listed on the energy technology list (which are scheduled to be updated in summer 2012) and the water technology list. Broad headings are listed below:

• Energy efficient plant and equipment (ECA)
• CO2 efficient cars
• Zero emission goods vehicles
• Plant or machinery for gas refuelling stations
• Water efficient technology (ECA)

Claiming these allowances can be particularly valuable, given that the writing down allowances (WDAs) for the main pool attract a deduction of 18% per annum; and many categories of plant and machinery will now be categorised as 'integral features' which attract 8% WDA.

Enterprise Management Incentives (EMI)

An EMI, which is commonly used by listed and privately held companies, is an HMRC approved share option plan designed to encourage employees to own shares in their employing company and to participate in the growth of the company. The employee can at any time hold options over shares to the value of £250,000 (£120,000 prior to 16 June 2012). The total value of unexercised EMI options (valued at the date of grant) that a company can issue is £3m.

The main benefit of the plan is that employees can acquire shares in the company without incurring an income tax liability and can participate in the increased value of shares at capital gains tax rates. In addition neither the award of the options or the exercise of the options gives rise to a national insurance liability which is advantageous to both the employee and the company.

Gains realised as a result of shares acquired through EMI qualify for entrepreneurs' relief (giving an effective tax rate of 10% on the gain realised) one year from the date of grant of option for disposals made on or after 6 April 2013.

For the company, the employee's gain on the option exercise can generate a corporation tax deduction at 23% (assuming the main corporation tax rate is in force from 1 April 2013).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.