UK: AIM Companies - Impact of Changes to VCT and EIS Rules

One of the advantages for companies listed on the Alternative Investment Market is that they can continue to benefit from a number of tax reliefs which are normally only available to unlisted companies. In particular shares in AIM companies can qualify for the purposes of the enterprise investment scheme (EIS) and venture capital trusts (VCTs). This can be an important source of capital for some AIM companies. Changes were announced in the Budget which will mean some AIM companies will find it more difficult to raise money through the EIS and VCT regimes.

EIS and VCT

Under the EIS scheme individuals who invest in ordinary shares in a qualifying company obtain certain tax reliefs. These include relief at 20% against income tax up to a maximum level (£200,000 pre-budget), exemption from CGT on disposal of the shares provided they are held for a minimum of three years and the ability to defer gains arising on the sale of other assets by rolling the gain into EIS shares.

VCTs are investment companies which allow individuals to acquire shares in an investment company which in turn invests in qualifying companies. VCTs are exempt from tax on gains realised on investments. In addition individuals who invest in VCTs receive relief against income tax on their initial investment plus an exemption from CGT on disposal of VCT shares and pay no income tax on dividends received from VCTs.

Reduction in size of company which can qualify A number of changes to the VCT and EIS schemes were announced in the Budget. The most significant change was a reduction in the maximum size of companies which can qualify for the purposes of the EIS and VCT schemes.

Prior to the Budget only companies whose gross assets were £15 million prior to any investment and £16 million after the investment could qualify. This has been reduced to £7 million and £8 million respectively. This is likely to take a number of AIM companies outside the scheme.

The new rules will apply:-

• to EIS shares issued on or after 6 April 2006 unless they were subscribed for before Budget Day (22 March 2006);

• to EIS investments made by Approved Investment Funds (AIF) where the AIF was approved on or after Budget Day. AIFs are arrangements which allow money from a number of investors to be pooled for the purposes of investing in EIS shares;

• to VCT money raised on or after 6 April 2006.

It appears that existing VCTs and AIFs will continue to benefit from the higher gross asset test. Some EIS and VCT money will therefore still be available to companies who have gross assets in excess of £7 million but the changes may impact on the ease with which they can raise new money.

A number of other changes to the VCT and EIS rules were announced as follows:-

• The 2004 Finance Act introduced a temporary increase in the rate of income tax relief for VCT investments from

20% to 40%. This was due to revert back to 20% on 6 April 2006. The rate of relief from 6 April 2006 will now be 30%;

• The qualifying holding period for VCT shares which is the period individuals must hold their VCT shares in order to qualify for relief is extended to 5 years;

• VCTs must hold a proportion of their investments in qualifying shares and securities. From 6 April 2007 money held by the VCT will be taken into account for the purposes of this test;

• The amount in respect of which individuals can claim EIS income tax relief will be increased from £200,000 to £400,000.

In general the impact of these changes should be to make the tax advantages of EIS and VCT investments more attractive to investors, but because EIS and VCT investments will have to be made in smaller companies investments will be riskier.

AIM companies continue to benefit from a number of other tax reliefs not available to companies listed on the London Stock Exchange. These include:-

• The higher rate of taper relief is available to all shareholders not just employee shareholders. This means that investors pay CGT at only 10% on gains made on the sale of shares after only two years. Tax would be payable at 40% on an equivalent sale of LSE listed shares;

• Shares in AIM companies will in general qualify for full exemption from inheritance tax;

• In certain circumstances income tax relief is available for losses arising on investments made in AIM companies.