The Pre-Budget Report may have focused attention on what the Chancellor will deliver in April but 2002’s Budget is still giving the private equity industry plenty to chew over. Legislation included in the UK’s Finance Act 2002 could provide a much-needed boost to corporate venturing, which is flagging in the current economic climate. Under the Exemption for Substantial Shareholdings (ESS) legislation companies could receive new tax relief on corporate venture capital investments. The tax breaks offered are more efficient than those already available to corporate venturers under the existing Corporate Venturing Scheme (CVS).
Peter Denison-Pender, a principal at Interregnum where he advises corporate clients on venture capital investing in IT, said: “Many feel that the widely publicised CVS is over complex and the scheme has been under-utilised. ESS, however, is simple and effective and dovetails neatly with the original intentions of the CVS to increase corporate venturing activity in the UK.”
The much-lauded CVS was introduced as part of the Finance Act in 2000 to encourage corporate venturing through direct investments, spinouts or acquisitions (see evcj November 2000). The scheme offered incentives such as investment relief against corporation tax of up to 20 per cent of the amount invested, loss relief against income for any capital loss on the exit and the deferral of tax on gains. Although this is only available if the company reinvests in CVS qualifying investments. “The scheme is admirable in conception but is fiddly and complex and not particularly generous in execution,” says Denison-Pender.
Corporates hoping to take advantage of the scheme face obstacles in the shape of numerous restrictions. The investing corporate must not own more than 30 per cent of the investee company and the investee company must not have gross assets exceeding £16 million after the investment. Qualifying shares must also be ordinary shares, preventing sophisticated capital structures being established to make investments less risky. Overall CVS does not encourage those corporate venturers that the Chancellor was targeting. It merely serves as a minor additional incentive to mid-sized companies rather than attracting the larger companies that would invest on a much larger scale. Perhaps unsurprisingly, uptake of CVS has been dismal.
The new ESS legislation was actually designed to create a more attractive tax environment for multinationals and its benefits to corporate venturing are unintentional. However, its terms are more straightforward and have been welcomed; when a qualifying investor disposes of a substantial shareholding in a qualifying company any gain will be exempt from corporation tax and any loss will also be disregarded. The investor must have owned at least 10 per cent of the investee company for a continuous period of 12 months during the two years before the disposal.
Bernard Hallewell, managing director of DTI-supported Corporate Venturing UK, which provides a match-making service for companies looking to invest and small businesses seeking funds, said: “This is good news as these tax breaks should bring a new lease of life to corporate venturing. For companies considering the merits of such a venture, this could be the incentive required for them to take the plunge into this new market.” Other benefits for corporate venturers include access to licensing deals, co-ownership of intellectual property or access to new target markets.
Denison-Pender adds: “These two strands of tax legislation have significant overlap, allowing potential corporate venturers to explore both beneficial tax avenues. The net effect is a new set of incentives to encourage companies to undertake corporate venturing programmes.”
Example of combined use of ESS and CVS
A company buys between 10 per cent and 30 per cent of qualifying corporate venturing investee company equity and sells at a capital gain three years later:
Investment relief under CVS @ 20per cent received immediately on investment = £100,000
Disposal proceeds treated as substantial shareholding- £10,000,000
Capital gain (proceeds – costs) = £9,500,000
Exempt capital gain = £9,500,000
Amount chargeable to tax upon disposal NIL
Net effect post Budget 2002 = £8,500,000 +ve (assuming arbitrary theoretical £1m deferral under original CVS)