EXPLANATORY NOTE

1. Clause 63 and Schedule 17 amends the Enterprise Investment Scheme (EIS) to–

• reduce the minimum period for which investors must hold their shares to qualify for income tax relief and capital gains tax disposal relief, so that the period is reduced from at least 5 years to at least 3 years;

• preserve reliefs where a company in which an investment has been made goes into receivership;

• modify the rules which determine whether a company is under the control of another person;

• make it easier for companies whose trade consists in receiving royalties and licence fees to qualify under the Scheme; and

• align the definition of research and development with that used for capital allowances and research and development tax credits.

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2. Clause 63 provides for Schedule 17 to have effect. Part I of the Schedule makes amendments reducing various periods which apply in relation to the reliefs available under the Scheme, Part II amends the rules for qualifying companies and Part III makes other minor amendments.

ENTERPRISE INVESTMENT SCHEME: AMENDMENTS

3. Paragraph 1 amends the definition of "eligible shares" so that the

conditions to be met by the shares must be satisfied throughout a period beginning with their issue and ending immediately before "the termination date" (see paragraph 8 of this Note) relating to those shares.

4. Paragraph 2 substitutes "the designated period" for "the seven year period" as the period throughout which an investor must not be connected with the issuing company if he or she is to qualify for income tax relief. "The designated period" means the period beginning two years before the issue of the shares and ending immediately before the termination date (see paragraph 8 of this Note) relating to those shares.

5. Paragraph 3 provides for "the designated period" to be the period throughout which an EIS investor must receive no payment as a director of a qualifying company if he or she is to be regarded as unconnected with the company. Paragraph 3 also amends the period during which an investor who becomes a paid director of a qualifying company after subscribing for eligible shares can make a further subscription which qualifies for income tax relief. This period will now begin with the issue of the shares and end immediately before the termination date (see paragraph 8 of this Note) relating to those shares.

6. Paragraph 4 substitutes "the designated period" for "the seven year period" as the period during which the receipt of value by the investor from the qualifying company may trigger the reduction or withdrawal of income tax relief, or the loss of deferral relief.

7. Paragraph 5 amends the provision dealing with the repayment, redemption or repurchase of any of the share capital of a qualifying company held by members other than those who would have their income tax relief reduced or withdrawn, or lose their deferral relief, as a consequence. It substitutes "the designated period" for "the seven year period" as the period during which the repayment etc., may trigger a charge reducing or withdrawing income tax relief. The provision which apportions value between two or more issues of shares is amended so that it applies irrespective of whether the period related to the issue is a 7 year period or a designated period.

9. Paragraph 7 brings the EIS deferral relief provisions into line with those for income tax relief by replacing references to the existing periods which end five years after the shares were issued by references to "the designated period".

10. Paragraph 8 provides for the changes in Part I to have effect for shares issued on or after 6 April 2000.

11. Paragraph 9 provides for amendments to the EIS legislation so that a company in administration or receivership is not regarded as ceasing to exist for the purpose of carrying on a qualifying trade or trades by reason of anything done as a consequence of its being in administration or receivership. This is subject to the making of the order, and everything done as a consequence, being done for bona fide commercial reasons and not as part of a scheme or arrangement the main purpose of which, or one of the main purposes of which, is the avoidance of tax.

12. Paragraph 9 also provides that where a company trades for less than 4 months because it goes into administration or receivership for bona fide commercial reasons, then the period for which trading must have been carried on before a claim for income tax relief can be made is reduced accordingly. In addition it makes necessary consequential amendments and introduces definitions of "in administration" and "in receivership" by reference to the relevant provisions of the Insolvency Act 1986 and any corresponding order under the law of Northern Ireland or the law of a country or territory outside the UK.

13. Paragraph 10 removes one of the two conditions which must currently be met if a company which is wound up or dissolved is to be treated as a qualifying company.

14. Paragraph 11 amends the rule which determines whether a company is "controlled" by another company. The company must not at any time in the relevant period control on its own or with a connected person any company which is not a qualifying subsidiary, or be a 51 per cent subsidiary of another company or otherwise under the control of another company or another company and any connected person. No arrangements must be in existence at any time in the relevant period which could lead to the company controlling another company other than a qualifying subsidiary, or being controlled, or being a 51 per cent subsidiary of another company or otherwise under the control of another company without being a 51 per cent subsidiary, whether in that period or otherwise. For the purpose of determining whether a qualifying company is controlled, ‘control’ has the meaning given in section 840 ICTA 1988.

15 Paragraph 12 provides for changes in Part II to have effect in relation to shares issued on or after 21 March 2000, and, in relation to shares issued before then to which deferral relief or income tax relief was still attributable at that date.

16. Paragraph 13 provides for the existing provision for companies which receive royalties or licence fees from research and development or film production to be replaced by a wider provision which allows any trade which consists to a substantial extent of receiving royalties or licence fees attributable to the exploitation of relevant intangible assets. The whole or the greater part of the intangible asset in terms of value must have been created by the company carrying on the trade, or by a company which was the parent company of the company carrying on the trade or a subsidiary company of that parent company. In the case of an intangible asset which is intellectual property, "created" means creation in circumstances where the right to exploit it vests in the company either alone or jointly with others.

17. An intangible asset means any asset so treated under normal accounting practice applying to UK companies. Intellectual property means any patent, trade mark, registered design, copyright, design right, performer’s right or plant breeder’s right and extends to similar corresponding rights of countries outside the UK. What is meant by ‘parent company’ and ‘qualifying subsidiary’ is also defined and effect is given to the changes in relation to shares issued on or after 6 April 2000.

18. Paragraph 14 provides a definition of ‘arrangements’ for the purposes of the Scheme which has effect for shares issued on or after 21 March 2000 and with effect from that date for shares issued earlier if income tax relief or deferral relief was still attributable to them at that date.

19. Paragraph 15 changes the definition of research and development for the purposes of the Scheme to align it with the definition used for capital allowances and research and development tax credits. This change applies to shares issued on or after 6 April 2000 but does not affect shares issued before that date.

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20. The EIS is designed to help small higher-risk, unquoted trading companies raise start-up and expansion finance by issuing full-risk ordinary shares. Individuals who are previously unconnected with companies in which they invest may obtain various income tax and capital gains tax reliefs, in particular:

• income tax relief (at 20 per cent) on the amount invested (on investments of up to £150,000 per tax year) and relief from capital gains tax on disposal of the shares, provided that shares are held for a specified minimum period ;

• relief for any allowable losses on the shares against either income or chargeable gains; and

• deferral of capital gains tax on a chargeable gain from the disposal of any asset where the gain is reinvested under the Scheme.

Deferral relief can also be obtained by individuals who have a prior connection with the company, and by the trustees of certain trusts.

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