Who said that the recent Emergency Budget was all doom and gloom? Amendments are to be made to the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) within the forthcoming Finance Bill, although the exact timings are still uncertain, which generate significant tax advantages to international companies looking to the UK for investment.
The current rules of the EIS/VCT require that the purpose of the share issue is to raise money for a “qualifying business activity”. In broad terms this requires that the issuing company (or its 90% owned subsidiary) carries on a qualifying trade or research and development activity “wholly or mainly” in the UK.
The proposed change is to remove the “wholly or mainly” requirement with respect to the conduct of the trade or R&D activity and to replace it with a simple requirement that the issuing company must have a Permanent Establishment (“PE”) in the UK.
The definition of PE is that found in Article 5 of the OECD Model Tax Convention. Again in very broad terms a PE means either:
(a) A fixed place of business through which the business of an enterprise is wholly or partly carried on; or
(b) The existence of a dependent agent acting with contractual authority on behalf of the enterprise
A fixed place of business will generally require the existence of premises and personnel and will necessarily give a taxable presence in the UK requiring the submission of UK tax returns and the assessment to corporation tax of the profits attributable to that PE.
A curiosity of the proposed drafting of this new requirement is that it does not appear to require the qualifying trade or R&D activity to be carried on through the PE: simply that the issuing company has a UK PE (although in most cases it is likely that the PE will be carrying on part of the qualifying trade).
Circumstances under which these changes may be beneficial
1. It has always been possible for a UK resident company to carry on part of its qualifying trade outside the UK provided the main part of the trade was conducted in the UK. Carrying on a trade mainly in the UK has generally been thought to require that more than 50% of the trading activity is conducted in the UK. The removal of the “wholly or mainly” test would seem to allow a greater percentage of the activity to be conducted abroad provided some part of the trade remains in the UK: this to satisfy the PE test. On this basis only a relatively small percentage of the activity needs to be in the UK.
2. It has always been theoretically possible for a non resident company to qualify under the EIS although the “wholly or mainly” requirement made this very difficult in practice. Under the proposals a non resident company carrying on part of its trade in the UK through a PE should qualify. However the issuing company must carry on the trade, not its subsidiary, as the requirement is that the issuing company has the PE.
On the basis that the requirement of the issuing company is simply to have a PE in the UK (rather than it should carry on part of the qualifying trade through the PE) then other possibilities arise.
3. A non UK group may carry on the qualifying trade through its wholly owned subsidiary. This would not qualify without the existence of a PE in the UK. Moreover the PE must (although the logic for this is not clear) be that of the parent company not the trading subsidiary. Accordingly any trading presence (PE) that the subsidiary might have otherwise established in the UK, for example a UK distributor or UK manufacturing presence, should be structured as a PE of the parent company.
4. If the non UK group has no “natural” trading presence in the UK can one be established by way of outsourcing business requirements to the UK? This would appear possible but the requirement of a PE will require premises and personnel in the UK in conducting this activity.
5. It may be appropriate to “import” the issuing company (or where the issuing company is a UK incorporated company to prevent its “export”) by arranging for the control and management of the company to be conducted from the UK. A place of management is an example of a PE. This would require the board to exercise control of the company through a fixed place of business in the UK. It would appear possible to have a UK resident parent company with all its trading activities undertaken outside the UK through non resident wholly owned subsidiaries: the issuing company satisfying the requirement of PE as a consequence of having its place of management in the UK.
Again I should emphasise that the changes have yet to be legislated for and the possibilities outlined at 3-5 are based on the draft legislation (and assume that there will be no requirement that the trade should be conducted in part through the PE) which may be more generous than intended. It should also be borne in mind that the EIS rules are themselves still quite restrictive notwithstanding the proposed removal of the “wholly or mainly” test. In particular the recent introduction of a limit of 50 employees for the issuing company and its group remains a constraint for more mature businesses.
Despite these points, the recent Emergency Budget can be seen as a positive for these small, fast growing companies with a PE in the UK with predominantly overseas activities looking at raising funds which now, subject to the passing of the Finance Bill, open the doors to both individuals looking to invest under the EIS rules but also to fund investing under the VCT rules. Perhaps the Emergency Budget wasn’t all about raising taxes and cutting public spending after all...
If you are interested in the above or have any questions, please contact me or Neil Simpson, Tax partner in our corporate finance department.
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