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Xenophobic Reliefs? - Enterprise investment scheme and enterprise management incentives scheme -- do we have to stay at home, asks IAN LEIGH, tax partner at Jeffreys Henry.

13 December 2000
Issue: 3787 / Categories:
Xenophobic Reliefs?

Enterprise investment scheme and enterprise management incentives scheme – do we have to stay at home, asks IAN LEIGH, tax partner at Jeffreys Henry.

ENTERPRISE INVESTMENT SCHEME legislation has quite rightly attracted heavy criticism for being tortuous in the extreme. Fuelled by the paranoia of tax avoidance, there seem to be so many hurdles in place that the honest investor might be forgiven for thinking it is just not worth the effort. Should investment decisions simply be made on commercial rather than fiscal grounds – perish the thought!
Xenophobic Reliefs?

Enterprise investment scheme and enterprise management incentives scheme – do we have to stay at home, asks IAN LEIGH, tax partner at Jeffreys Henry.

ENTERPRISE INVESTMENT SCHEME legislation has quite rightly attracted heavy criticism for being tortuous in the extreme. Fuelled by the paranoia of tax avoidance, there seem to be so many hurdles in place that the honest investor might be forgiven for thinking it is just not worth the effort. Should investment decisions simply be made on commercial rather than fiscal grounds – perish the thought!

Territorial requirement

One particular area of concern is the territorial requirement for United Kingdom trading. Statement of Practice 3/00 deals with the location of activity for the purposes of the scheme and, whilst it indicates the topics which the Revenue will look into, it is suitably vague:
'… the Inland Revenue will take into account the totality of the activities of the trade … No one factor is in itself likely to be decisive …'

This is intended to elaborate on the test as to whether a trade is 'carried on wholly or mainly in the United Kingdom'. It is clear that where there is a singleton company more than half of the trading activity needs to be in the United Kingdom. But what about the position for a group of companies? We live in a small island and as business takes on an increasingly international flavour, United Kingdom trading can be subsumed within a wider group of companies based in a number of different countries. Does it follow that over 50 per cent of the group's activities as a whole must be concentrated in the

United Kingdom?

Expansion overseas
This may not be a problem when the initial funds are raised under the enterprise investment scheme but the question may have to be asked when that company looks to expand overseas? Enterprise investment scheme conditions are typically set by reference to the three year relevant period, so the company needs to follow the enterprise investment scheme rulebook religiously for the duration of that period.

In a group situation, the company must satisfy the definition of 'parent company of a trading group' referred to in section 293(3A), Taxes Act 1988 in order to be a 'qualifying company' within the meaning of the section. There are effectively two tests to apply to the group:
the subsidiaries must be 'qualifying' subsidiaries, i.e., the parent has a 75 per cent interest as defined in section 308(2);
if all the activities of the parent and subsidiaries are taken together as a single business then a 'substantial' part does not relate to either of the following:
excluded trades (covering the usual prohibitions – land, leasing etc.);
non trading activities.

The meaning of 'substantial' has been well rehearsed and most practitioners will be familiar with the magical 20 per cent. But where does the United Kingdom trading test fit into the definition? The answer is that it does not. The group is simply considered in terms of whether at least 80 per cent of the combined activities relate to non-excluded trades irrespective of where the trades are carried on.

The location of the trade is dealt with separately in section 289 which sets out the requirement that the enterprise investment scheme money be raised for the purposes of a 'qualifying business activity' carried out by the 'active company'. Thus there are yet another two definitions to mull over:
'qualifying business activity' is defined in section 289(2)(a) as carrying on or preparing to carry on a qualifying trade (i.e., a non excluded trade) 'wholly or mainly in the United Kingdom'. This applies throughout the relevant period.
the 'active company' can either be the parent or a 90 per cent subsidiary (section 289(1A)) and must exist 'wholly for the purpose of carrying on one or more qualifying trades ... apart from purposes capable of having no significant effect … on the company's activities' (section 289(1B)).

The recent article, 'Substantial or Significant?' by Roger Jones in Taxation dated 19 October 2000 at pages 55 to 56 considered the need to differentiate the terms 'significant' and 'substantial' in the context of the enterprise investment scheme and taper relief legislation. The 80 per cent rule relates to substantial only. When looking at the active company it really needs to be almost entirely a trading company .Within the trade up to 20 per cent of the activity can relate to excluded trades.

How important is location?

Attempting to weave the strands together, the territorial rule in section 289 is saying that monies raised under the enterprise investment scheme by a group parent must be for the use by any group company which is fully trading and more than 50 per cent of that trade is United Kingdom based.

It does not seem to matter that the group as a whole may conduct more than 50 per cent of its trade outside the United Kingdom, as there is no territorial aspect to the definition of qualifying company within section 293. The legislation is primarily concerned with funding United Kingdom trading and so the key is to establish a clear nexus between the share subscription and the application of monies towards the United Kingdom trade.

It is well understood that the enterprise investment scheme company itself does not have to be a United Kingdom resident company. Taking this further, one could envisage claiming enterprise investment scheme relief for a subscription of shares in an overseas group with a single United Kingdom subsidiary in order to fund, say, United Kingdom office costs even if the United Kingdom represents a small component of the groups total business. This is potentially anomalous in that future growth in value which could be exempt from capital gains tax after three years for the investor may derive principally from non United Kingdom business. Perhaps it is enough that the enterprise investment scheme subscription has funded United Kingdom activity and contributes to United Kingdom plc, even if the true value lies elsewhere.

Enterprise management incentives

A similar situation applies in relation to enterprise management incentives. Firstly, a parent company must only have 'qualifying subsidiaries' as defined in paragraph 15 to Schedule 14 of the Finance Act 2000, but this is again simply by reference to 75 per cent interests.
Paragraph 17 deals with the trading activities tests and subsection (2) requires that:
'(a) the business of the group does not consist wholly or to a substantial part in the carrying on of non-qualifying activities and;
(b) at least one group company -
(i) disregarding any incidental purposes, exists wholly for the purposes of carrying on one or more qualifying trades and;
(ii) is carrying on a qualifying trade or preparing to do so.'

In effect there are separate trading tests for the group as a whole in paragraph 17(2)(a) and for at least one group company in paragraph 17(2)(b). The need to trade 'wholly or mainly in the United Kingdom' only applies to the second test in paragraph 17(2)(b) through the reference to a 'qualifying trade'. The group test in paragraph 17(2)(a) relates to non-qualifying activities which are defined in paragraph 17(6) broadly as:
excluded activities (the usual enterprise investment scheme suspects);
non-trading activities.

There appears to be no territorial limit placed on non-qualifying activities as it is the nature of the activity which counts rather than the location. Thus provided the group is substantially trading (and not excluded trades), the parent can qualify for enterprise management incentives if it has at least one subsidiary trading wholly or mainly in the United Kingdom, notwithstanding the greater part of the group's operations being based abroad.

More guidance needed

For both enterprise investment schemes and enterprise management incentives there is a clear need for a separate United Kingdom trading company that remains largely untainted by non-United Kingdom business.

It would help if we had a better idea of the Revenue's interpretation beyond the views set out in Statement of Practice 3/2000. An entrepreneurial economy relies on foreign markets and foreign sourcing, and if United Kingdom jobs are generated in the process, then the fiscal stimulus offered by enterprise investment schemes and enterprise management incentives is surely warranted.
The Statement of Practice tells us that companies can buy and sell abroad without losing United Kingdom trading status, but this is hardly sufficient guidance.

A trip through the legislative maze suggests that the reliefs may be more generous on the United Kingdom trading requirement than at first thought.
Companies now need some practical guidelines to allow for overseas expansion without jeopardising the tax breaks enjoyed by their shareholders and employees.


Issue: 3787 / Categories:
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