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Mr. Andrew Slaughter accordingly presented a Bill to require police services to include proposals to introduce and sustain neighbourhood policing as a provision of their policing plans; and for connected purposes.: And the same was read the First time; and ordered to be read a Second time on Friday 16 June, and to be printed [Bill 177].
The Chairman of Ways and Means (Sir Alan Haselhurst): With this, it will be convenient to discuss the following amendments: No. 7, in page 74 [Vol II], leave out from beginning of line 27 to end of line 4 on page 75.
Mr. Hoban: The first four amendments in this group deal with issues to do with the gross assets of investee companies. Those matters come into sharp focus as a consequence of the proposed reduction in the gross assets limit for venture capital trust investments. The final amendment in the group deals with changes announced in the Budget to the treatment of the VCT's own assets.
One of the most significant changes to the rules applicable to VCTs and enterprise investment schemes is the Bill's proposed reduction in gross asset limits, and
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amendments Nos. 6, 7 and 8 would reinstate the limits that apply under the current legislation. The current rules state that gross assets should be equal to, or less than, £15 million prior to fundraising and £16 million after fundraising. That allows the very largest qualifying companies to raise £1 million.
The proposed changes will reduce the gross assets limit so that a company will have no more than £7 million in gross assets prior to fundraising and no more than £8 million afterwards. The effect will be to reduce the amount that certain companies are able to raise. At present, a company with gross assets of £6 million is able to raise an additional £10 million through fundraising, but in future it will be able to raise only about £2 million. I am concerned about the effect on the operation of VCTs, and about the nature of the companies in which they can invest.
If a VCT invests now in a company whose gross assets before investment comply with the new rules proposed in the Bill, its ability to make a follow-on investment will be restricted. Under the current rules, however, the VCT can make further investment in the company until the £15 million asset limit is reached.
My experience before I came to the House was that early investors can find that their holdings and interest are diluted by people who come in later. It is often in their interest to make follow-on investments to maintain the size of their interest in the company. Reducing the gross assets limit from £15 million will restrict VCTs' ability to do that if the company hits the proposed new £7 million limit.
Secondly, the proposed reduction in the gross assets limit is that it could change the asset base that VCTs and the Enterprise Investment Scheme can invest in. The focus will be on smaller, and therefore arguably more risky, companies.
The lower gross asset limit proposed by the Government will focus more finance on the companies in the funding gap identified in the Treasury publication entitled "Bridging the Gap", but there is a feeling that some slightly larger companies will still find it difficult to attract investment. The proposed reduction in the gross assets limit will exclude them from this source of investment, with the possible unintended consequence that the funding gap is moved further upthat is, that the needs of smaller companies will be met, but that slightly larger companies will lose out.
It is not just manufacturing businesses that are asset rich. Last week, I visited a firm in my constituency that acts as a data centre for businesses, housing the servers that they need to power and maintain their websites. It is a relatively small business with about 30 employees but the cost of its data centre, including plant, cooling and some security measures, is extremely high relative to its turnover and its employee numbers.
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We must recognise that even a relatively small service business can be asset intensive and fall outside the limits set out in the Bill. Is it right that asset-intensive businesses are squeezed out of such funding? The Minister will argue that the problem would exist at whatever level the gross assets limit is set, and that is true. In a way, it is a crude proxy for company size, but the reduction in the gross assets limit from £15 million to £7 million makes the problem all the more evident. As asset levels fall, it is likely that more businesses will find funding through VCTs difficult to access.
I should be grateful if the Minister would explain the basis on which the new lower gross assets figures were determined and say what steps he will take to monitor the flow of funds into VCTs and the EIS and the nature of the companies in which those funds are invested to ensure that the reduction does not adversely affect companies seeking funds. Will he also ensure that the measure does not simply lead to the funding gap moving up from companies with assets of less than £15 million to companies that previously would have benefited from funding through VCT schemes?
Mr. Brooks Newmark (Braintree) (Con): Does my hon. Friend recognise that moving to lower asset values and smaller companies will mean a much greater inherent risk to those investing in such companies?
Mr. Hoban: My hon. Friend is absolutely right. When companies have lower asset values there is an increase in the level of risk, which will prompt investors to consider the risk-return ratio and think about whether their likely returns from VCTs in the future are sufficient to warrant that investment being made. The Government need to monitor that carefully to ensure that having turned the tap on in VCT funding by increasing the tax relief, a matter to which I will return in later amendments, the consequential changes in the Bill of reducing that relief, increasing the holding period and reducing the gross assets limit, will make VCTs less attractive to investors, thus depriving smaller businesses of the funds that they need to expand and grow. My hon. Friend was quite right to highlight the importance of risk and its role in assessing these investments, and the relationship between small businesses and risk.
Amendment No. 9 relates to the definition of gross assets that is set out in the Income and Corporation Taxes Act 1988. The amendment revisits that definition, taking into account changes in accounting practice that might have an adverse effect on companies' ability to access funds from VCTs in the future. It is, I regret, a highly technical amendment relating to the definition of gross assets of an investee company. Under UK generally accepted accounting practice, companies were given a choice with regard to the capitalisation of development expenditure: they could capitalise it or expense it. The rules setting out the basis on which that could take place were set out in the standard statement of accounting practiceSSAP 13"Accounting for Research and Development".
The permissive nature of SSAP 13 in giving companies that choice, together with the wide application of the prudence concept, generally resulted in businesses writing off development expenditure in
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their profit-and-loss account. For companies seeking investment from VCTs, and through the EIS, that was good news, because there was no addition to their gross asset figures.
However, although UK accounting standards remain in place for unlisted companies, listed companies are adopting international financial reporting standards and one of the differences between UK and international standards is the treatment of development costs. Under international standards, development costs can be capitalised if they meet one of the following six criteria: the technical feasibility of the project; the intention to complete the intangible asset for use or sale; the ability to use or sell the intangible asset; how the intangible asset will generate probable future economic benefits; the adequacy of the resources for completion; and the ability to measure reliably the development expenditure.
The criteria are broadly similar to those used under SSAP 13 and are designed to ensure that only costs clearly identifiable as relating to a project that will be completed, which the company can afford to complete and which will yield financial benefits will be capitalised. In essence, they ensure that only costs that can lead to a realisable asset will be capitalised. If international financial standards matched SSAP 13 in their entirety, there would be no issue, as a company would be unlikely to capitalise those costs. However, there is a vital difference from SSAP 13: the relevant international standard states that where the six criteria are met, the costs shouldI emphasise the word "should"be capitalised.
So where is the issue for VCTs and investee companies? Capitalised development costs will count towards the gross assets test. That is increasingly important for two reasons: first, the lower gross assets test will bite, and secondly, although the Treasury might argue that IFRS apply only to listed companies and are thus unlikely to become an issue for unlisted companies, in reality I suspect that companies will increasingly adopt IFRS as a basis for reporting. That will be of particular interest to companies who may want an exit route through a listing in the future and may want to implement IFRS from the outset rather than restate their accounts at a later date. Having worked on such exercises in the past, I should prefer to start off with the basis on which I intend to report my results, rather than changing it partway through. If nothing else, it would save on the fees businesses pay to organisations such as my former firm.
In practice, the adoption of IFRS is likely to mean that more development expenditure will be capitalised than under UK GAAP. Coupled with the reduction in gross asset rules, that could lead to fewer companies in need of capital qualifying for investment under VCT rules. As my hon. Friend the Member for Braintree (Mr. Newmark) suggested, there could be a double effect: first, there will be a change in accounting standards and, secondly, the lower gross asset figure will bite at much smaller companies. The changes will have an impact, in particular, on the software and pharmaceutical industries, many of which seek VCT investment.
We believe that the decision to transfer to accounting under IFRS should not be hampered by the need to consider that potentially extremely significant adverse
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impact. I would be grateful for the Financial Secretary's thoughts on what is very much a probing amendment at this stage.
Amendment No. 13 covers the way in which VCTs manage their assets. Again, it is a technical amendment, which highlights the concerns of a number of VCT managers and their advisers. One of the challenges that faces a VCT is how to manage its investments and any cash balances, while ensuring that once the initial investment period is over it complies with the rule that 70 per cent. of its investments are in qualifying investmentsthat is, investments in unlisted companies. Changes under the Finance Bill have an impact on the way that VCT managers can manage the affairs of their trusts. Historically, a VCT could place cash in non-interest-bearing accounts as a short-term measure to try to meet the 70 per cent. rule.
Let me give an example to explain more clearly. A venture capital trust with investments of £10 million fully invested in unlisted companies would meet the criteria as 100 per cent. of its investments are in qualifying companies. A VCT could, for commercial reasons, decide to realise an investment of £4 million. If it put the cash in an interest-bearing account, it would have investments of £10 million but qualifying investments of only £6 million. Therefore, it would fail the 70 per cent. test. Under current rules, the VCT would be able to place the £4 million in a non-interest-bearing account and achieve the 70 per cent. rule by having £6 million in investments and £6 million in qualifying investments. It could then act to return that cash to its shareholders or make a further investment in another company without losing its qualifying status, because it would not be in breach of the 70 per cent. rule.
There are strong reasons why VCTs would seek to use the cash as soon as possible. Investors focus on returns and if one invests the realised proceeds in a non-interest-bearing account, that is not very good for the overall return of the VCT. There is an opportunity under the existing rules to manage the VCT more smoothly, but there is also commercial pressure to ensure that the assets are used as quickly as possible and in a way that does not disturb the orderly management of the VCT.
Under the rules in the Bill, that opportunity would no longer be available to VCTs and the concerns of managers have fallen into two categories. Those in the first group say that they would rather the rules were not changed at all. They would make it easier for all VCTs to handle non-interest-bearing deposits and to put cash into them to ensure that the 70 per cent. rule applies. Those in the other group suggest that the rule should not apply to VCTs that have already been set up. Managers might have taken different decisions if they had known that the relief was to be removed from the VCT. Under amendment No. 13, when a VCT has raised money before 6 April 2006, the money could still be placed in non-interest-bearing deposits and fall outside the definition of investments to ensure that it would be easier for VCTs to meet the 70 per cent. rule while bearing in mind that there will still be the commercial pressure to ensure that the money is returned to shareholders or reinvested as soon as possible.
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In conclusion, amendments No. 6, 7 and 8 seek to elicit from the Government their reasoning for reducing the gross asset test and to establish whether they have fully thought through the impact of that on the potential investments of VCTs. Amendment No. 9 seeks to change the definition of gross assets to reflect changing accounting treatment and to find a way in which the reduction of gross asset test could be mitigated to the benefit of certain companies that invest in, and spend a great deal of money on, development. Amendment No. 13 seeks to make it easier for VCTs to manage their own assets in an ordered way rather than having to act precipitately when a realisation is made.
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