House of Commons - Explanatory Note
Income Tax Bill - continued          House of Commons

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This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 58: VCT: definition of eligible shares for VCT relief: clause 273 and Schedule 2 Part 8 (interpretation of Chapter 2)

This change prevents the contention that section 73(1)(b) of FA 1998 was ineffective in deleting the word "preferential" from the definition of "eligible shares" in paragraph 6(1) of Schedule 15B to ICTA.

Paragraph 6(1), in common with section 842AA(14) of ICTA, originally defined "eligible shares" in terms of shares in a company which:

carry no present or future preferential right to dividends or..assets on its winding up and no present or future preferential right to be redeemed.

Section 73(1)(b) of FA 1998 omitted the italicised reference to "preferential". Section 73(6) of FA 1998 provided that the omission had effect:

for the purpose of determining whether shares or securities are, as at any time on or after 6th April 1998, to be regarded as comprised in a company's qualifying holdings..

Section 73(1)(a) made a similar omission of the word "preferential" from section 842AA(14).

Section 73(6) sits well with section 73(1)(a) because section 842AA deals with a company's qualifying holdings; but paragraph 6(1) is in Part 1 of Schedule 15B which deals with whether or not an individual is eligible for VCT relief on particular shares.

FA 1998 also omitted the word "preferential" in relation to other provisions associated with venture capital schemes. These omissions were from:

  • section 289(7) of ICTA (enterprise investment scheme);

  • section 150(8A) of TCGA (business expansion scheme);

  • section 150A(8A) of TCGA (enterprise investment scheme); and

  • paragraph 9(2) of Schedule 5B to TCGA (enterprise investment scheme: reinvestment).

Section 74(3) of FA 1998 provided that those omissions had effect:

in relation to shares issued on or after 6th April 1998.

It seems likely that similar wording should have been used in relation to the omission in section 73(1)(b).

The words quoted earlier from section 73(6) FA 1998 are not reproduced in relation to clause 273(1). This prevents the contention that section 73(1)(b) of FA 1998 was ineffective in omitting the word "preferential" in paragraph 6(1) of Schedule 15B to ICTA.

Schedule 2 Part 8 (interpretation of Chapter 2) ensures that this change does not apply to shares issued before 6 April 2007.

This change is adverse to some taxpayers in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 59: VCT: conditions relating to value of investments: clauses 278 and 285 and Schedule 2 Part 8 (conditions relating to value of investments)

This change makes clear how the test in section 842AA(2)(d) of ICTA (referred to in this note as the 15% test) operates. It also makes clear how definitions in section 842 of ICTA apply for the purposes of 842AA(5) of that Act, which itself defines the value of a holding for the purposes of the tests in section 842AA(2) (b) to (d).

Section 842AA(11) applies certain provisions of section 842 to section 842AA and these have been included in the rewrite of section 842AA.

The opening words of section 842AA(11) are:

The following provisions of section 842 shall apply for the purposes of this section as they apply for the purposes of that section,..

Section 842AA(11)(a) provides that the conditions relating to "the 15% test" in section 842 shall apply to the equivalent test in section 842AA(2)(d):

subsections (1A) and (2) of that section [section 842] shall apply in relation to subsection (2)(d) above (but with the omission of subsection (2)(a) of that section) as they apply in relation to subsection (1)(b) of that section.

Section 842AA(11)(c) then further provides:

without prejudice to their application in relation to provisions applied by paragraph (a) or (b) above, subsections (3) and (4) of that section [section 842] shall apply in relation to any reference in this section to a holding or an addition to a holding as they apply in relation to any such reference in that section.

Section 842(3) defines a holding for the purpose of section 842(2). It states that:

" holding" means the shares or securities (whether of one class or more than one class) held in any one company.

Section 842(3) also defines an addition to a holding and explains what happens if there is a scheme of reconstruction.

It is not clear how the definitions in section 842(3) apply to section 842AA(5). Section 842AA(5) deals with the valuation of a holding and the circumstances under which this is revalued for the purpose of the conditions in section 842AA(2)(b) to (d).

It is possible to read the definitions in section 842(3) as applying only to the 15% test in section 842AA(2)(d) since the definition is of a holding "in any one company". Section 842AA(2)(d) refers to a holding "in any company" and there are no other examples of this sort of phraseology in section 842AA. In addition the definition in section 842 is of shares or securities (whether of one class or more than one class) while section 842AA(5) refers to a holding "of investments of the same description" and additions to such holdings. Furthermore it is not obvious how both the applied provisions in section 842 and section 842AA(5) can apply to this test given the wording of section 842AA(11)(c).

But the wording of section 842AA(11)(c) "any reference in this section to a holding or an addition to a holding" suggests that there is more than one such reference to which section 842(3) applies. In addition, if section 842(3) does not apply to section 842AA(5), there is no explicit guidance on the interpretation of an addition to a holding of investments. Also section 842AA(5) applies to all the percentage tests (the 70%, 30% and 15% tests).

In practice the provisions are currently interpreted on the basis that it is necessary to establish whether or not a holding has been added to in accordance with section 842(3), when an investment of any description is added to a holding of shares or securities.

Then the rules in section 842AA(5) are applied to revalue only the holding of investments of the same description as the investment added when applying the 15% test in section 842AA(2)(d).

The clauses are based on this approach and remove the possible doubt about the way in which section 842 and section 842AA interact.

Clause 277 of this Bill sets out the section 842 rules about when and how the 15% test applies. (In Part 6 of this Bill the 15% test is called "the 15% holding limit condition".)

In clause 278 of this Bill which rewrites section 842AA(5) and is concerned with the way a holding is valued when there is an addition, the section 842(3)(b) and (c) and section 842(4) definitions are adapted to the terminology in section 842AA(5).

The effect of this is that the rules in clause 278 apply to the 15% holding limit condition when there is an addition to investments of any description in the same way as they apply to the 70% qualifying holdings condition and the 30% eligible shares condition. A revaluation is required only of the holding of investments of that description. This is in line with interpretation and practice.

There is a transitional provision in Schedule 2 the purpose of which is to preserve the effect of section 842AA(11)(c) on the 15% test where there is an addition to investments held by a company before 6 April 2007.

Clause 285

This Change also has an impact on the interpretation of references to investments in clause 285.

Paragraph 8 of Schedule 14 to FA 2006 provides an interpretation of the references to a company's investments in section 842AA. Paragraph 8(1) also provides that the interpretation applies to references to investments in section 842(2)(b) of ICTA as this provision is applied to section 842AA.

The FA 2006 provisions do not extend this interpretation explicitly to the definitions in section 842(3) of ICTA which section 842AA(11)(c) applies to section 842AA.

The interpretation of investments in clause 285(4) to (6) applies to the whole of Chapter 3 of Part 6. It therefore covers the reference to investments in clause 278(4), which is derived in part from section 824(3) of ICTA. This subsection provides a definition of an addition of a holding for the purposes of valuing a holding of investments of any description. Applying the interpretation to this reference accords with the intention that the FA 2006 interpretation would be applied consistently in section 842AA.

The transitional provision for clause 285 in Schedule 2, is based on the commencement rule in paragraph 8(2) of Schedule 14 to FA 2006 and applies the interpretation from 6 April 2007.

This change is adverse to some taxpayers and favourable to others in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 60: VCT: excess over the maximum qualifying amount: clause 287 and Schedule 2 Part 8 (the maximum qualifying investment requirement)

This change provides that an investment in excess of the maximum qualifying investment is ignored in relation to later investments in the same company.

Schedule 28B to ICTA explains the meaning of a qualifying holding. In paragraph 1(1):

This Schedule applies, where any shares in or securities of any company ("the relevant company") are at any time held by another company ("the trust company"), for determining whether and to what extent those shares or securities ("the relevant holding") are, for the purposes of section 842AA, to be regarded as at that time comprised in the trust company's qualifying holdings.

In this Bill the trust company is called "the investing company".

Paragraph 7 of Schedule 28B to ICTA prevents an issue of shares or securities (the relevant holding) from being a "qualifying holding" to the extent that the "maximum qualifying investment" is exceeded for the "relevant period" at the time of the issue. Paragraph 7(2) and (5) define "maximum qualifying investment" and the beginning of the "relevant period" as follows:

the maximum qualifying investment for any period is exceeded to the extent that the aggregate amount of money raised in that period by the issue to the trust company during that period of shares in or securities of the relevant company exceeds £1 million.

and:

For the purposes of this paragraph the relevant period is the period beginning with whichever is the earlier of

    (a)     the time 6 months before the issue of the relevant holding; and

    (b)     the beginning of the year of assessment in which the issue of that holding took place.

The following example illustrates how paragraph 7 operates in relation to issues of shares or securities by company A to a VCT in the amounts and on the dates shown.

Relevant period startsIssue date£ Amount raised by A from VCT on issue date£ Amount(s) raised by A from VCT in relevant period£ Excess of Y over maximum qualifying investment.
= "excess part of X"
£ Amount of X within maximum qualifying investment
XYZX less Z
6/4/0431/3/05600,000600,000nil600,000
3/12/043/6/05800,0001,400,000400,000400,000
6/4/0531/12/05500,0001,300,000*300,000200,000

The intention was that the cumulative amount raised (column Y in the table) should only include earlier amounts raised to the extent that those amounts had fallen within the final column. So the asterisked total in the final row should be £900,000 and all of the £500,000 raised on 31 December 2005 should fall within the final column. Practice has reflected that intention.

Clause 287(3)(b) reflects the practice of not "double counting" an amount that represents an excess over the maximum qualifying investment within a relevant period.

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 61: VCT: the trading requirement and the carrying on of a qualifying trade requirement: clauses 290, 291 and Schedule 2 Part 8 (the trading requirement and the carrying on of a qualifying activity requirement)

This change enables certain requirements to be met in circumstances where the relevant company acquires a company after the issue of the relevant shares.

There are three aspects.

The change in clause 290(2)

Paragraph 3(2) of Schedule 28B to ICTA requires that:

The relevant company must be one of the following -

    (a) a company which exists wholly for the purpose of carrying on one or more qualifying trades..or

    (aa) the parent company of a trading group.

This is rewritten in clause 290(1).

The parent company of a trading group is defined in paragraph 3(6):

For the purposes of this paragraph a company is the parent company of a trading group if—

    (a)     it has one or more subsidiaries;

    (b)     each of its subsidiaries is a qualifying subsidiary of the company; and

    (c)     the requirements of sub-paragraph (7) are fulfilled by what would be the business of the company and its qualifying subsidiaries if all the activities, taken together, of the company and its qualifying subsidiaries were regarded as one business.

This is rewritten in clause 290(3) (and in clause 298, the qualifying subsidiaries requirement, and in clause 332, by the definition of "parent company").

Change 61 ensures that a relevant company can qualify as a parent company if there is the intention that one or more companies will become a qualifying subsidiary.

The new provision in clause 290(2) states:

If the relevant company intends that one or more other companies should become its qualifying subsidiaries with a view to their carrying on one or more qualifying trades—

    (a)     the relevant company is treated as a parent company for the purposes of subsection (1)(b), and

    (b)     the reference in subsection (1)(b) to the group includes the relevant company and any existing or future company that will be its qualifying subsidiary after the intention in question is carried into effect.

This subsection does not apply at any time after the abandonment of that intention.

The change in clause 290(6)

R&D is covered by the deeming provision in paragraph 4(1) of Schedule 28B to ICTA:

the carrying on of any activities of research and development from which it is intended there will be derived a trade .. shall be treated as the carrying on of a qualifying trade.

There are no requirements in this provision as to which company carries on the trade deriving from R&D.

Paragraph 3(9)(b)(i) of Schedule 28B to ICTA says (emphasis added):

3(9)     Activities of a company or of any of its qualifying subsidiaries shall be disregarded for the purposes of sub-paragraphs (6) to (8) above to the extent that they consist in—

    (a)     ..

    (b)     the holding and managing of property used by the company or any of its qualifying subsidiaries for the purposes of—

         (i)     research and development from which it is intended that a qualifying trade to be carried on by the company or any of its qualifying subsidiaries will be derived; or ..

The provision is rewritten in clause 290(5)(d) (with "a group company" instead of "the company or any of its qualifying subsidiaries" and with the impact of Change 41 which extends the R&D in the frame to R&D that will benefit a qualifying trade).

Clause 290(6) provides an interpretation of group company (as defined in clause 332), which makes it clear that here this includes future group companies:

Any reference in sub-paragraph (i) or (ii) of subsection (5)(d) to a group company includes a reference to any existing or future company which will be a group company at any future time.

Note

Clause 290(2) and (6) do not specify that the company that is not yet part of the group has to be a qualifying 90% subsidiary. But the relevant company in clause 290 has also to comply with other requirements such as those in clauses 291, 293 and 294. This will determine whether the new subsidiary is required to be a qualifying subsidiary or a qualifying 90% subsidiary.

The change in clause 291(8)

Clause 291 is based on paragraph 3(3), (4), (5), (5A) and (5B) of Schedule 28B to ICTA.

Paragraph 3(3)(b) and (4)(a) of Schedule 28B to ICTA set out certain required activities for a qualifying company (emphasis added):

(3) Subject to sub-paragraph (4) below, when the relevant holding was issued and at all times since, a qualifying company (whether or not the same such company at every such time) must have been either

    .. or

    (b)     preparing to carry on a qualifying trade which at the time when the relevant holding was issued was intended to be carried on wholly or mainly in the United Kingdom by a qualifying company

(4) The requirements of sub-paragraph (3) shall not be capable of being satisfied by virtue of paragraph (b) of that sub-paragraph at any time after the end of the period of 2 years beginning with the issue of the relevant holding unless

    (a)     the intended trade was begun to be carried on by a qualifying company before the end of that period, and ..

A "qualifying company" is defined in paragraph 3(5A) as:

the relevant company or any relevant qualifying subsidiary of that company.

A relevant qualifying subsidiary is defined in paragraph 5A of Schedule 28B to ICTA. This is rewritten as a qualifying 90% subsidiary in clause 301.

There is an indication in paragraph 3(5B) of Schedule 28B to ICTA that participation as a qualifying company is not restricted to existing subsidiaries (this is in relation to the commencement of the trade in paragraph 3(4)(a) of that Schedule).

This is also the intention behind the references to a qualifying company in paragraph 3(3)(b) of Schedule 28B to ICTA, rewritten in clause 291(3). This phrase includes a subsidiary that is acquired after the date the shares are issued so long as other requirements such as those in paragraph 6 (2B) to (2AG) of that Schedule, rewritten in clause 294, are met.

But, to make this clearer, clause 291(8) provides an interpretation of the reference in subsection (7) to a qualifying company which is a qualifying 90% subsidiary:

The reference in subsection (7) to a qualifying company which is a qualifying 90% subsidiary of the relevant company includes, in its application to subsection (3), a reference to any existing or future qualifying company which will be a qualifying 90% subsidiary of the relevant company at any future time.

EIS (the enterprise investment scheme) and share loss relief

There is a parallel to these changes in Part 5 (EIS) and to the changes in clause 290(2) and (6) in clause 137(2) and (6) and new section 576B(3) and (7) of ICTA relating to share loss relief.

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 62: VCT: trades whose carrying on by other persons prevents the relevant holding being a qualifying holding: clause 294 and Schedule 2 Part 8 (the relevant company to carry on the relevant qualifying activity requirement)

This change identifies more clearly the cases in which the carrying on of trades etc by other persons prevents a relevant holding from being a qualifying holding for the purposes of Chapter 3 of Part 6 (VCT approvals). The trade etc which is later carried on by other persons must be one for which money was raised by the issue of the relevant holding.

Paragraph 6(1) of Schedule 28B to ICTA (so far as relevant) provides that (emphasis added):

The requirements of this paragraph are that..the money raised by the issue of the relevant holding..been employed wholly for the purposes of the trade by reference to which the requirements of paragraph 3(3)..are satisfied..

From paragraph 6(2) and (2AA) it is reasonably clear that the trade in question must either have been carried on when the relevant holding was issued or have been one for which preparations to carry it on were then being made.

There is nothing preventing the relevant company from carrying on, or preparing to carry on, more than one trade when it issues the relevant holding. In such a case, if the relevant holding is issued to raise money for one of those trades (the funded trade), that trade will be the trade and the other trade(s) (unfunded trade(s)) will not.

Paragraph 6(2AB) of Schedule 28B (so far as relevant) provides that (emphasis added):

The requirements of this paragraph are not satisfied if..the trade by reference to which the requirements of paragraph 3(3) are satisfied, and any preparations for that trade falling within paragraph 3(3)(b).., are carried on..by a person other than the relevant company or a relevant qualifying subsidiary of that company.

Paragraph 6(2AB) refers to the trade for the purpose of determining if the requirements of paragraph 6 are not met. Paragraph 6(1) refers to the trade for the purpose of determining if the requirements of paragraph 6 are met. There is no explicit link between the trades referred to in each of these sub-paragraphs.

So it is arguable that, under paragraph 6(2AB), the subsequent carrying on of an unfunded trade by another person (not the relevant company or a relevant qualifying subsidiary of that company) prevents the relevant holding from satisfying paragraph 6; and that this result is unaffected by the relevant company continuing to carry on the funded trade.

But, in context, it is likely that paragraph 6(2AB) is limited to cases where the trade in question is the funded trade (the one that allowed the requirement of paragraph 6(1) to be met). That appears to be the more rational result and it is how HMRC interpret paragraph 6(2AB).

And a broadly similar provision in section 289(1A) of ICTA (enterprise investment scheme) looks at who is carrying on the various activities for which money has been raised by an issue of shares.

Clause 294(1) rewrites paragraph 6(2AB) on the basis that its restrictions about trades etc only apply to trades etc that allow the requirement of paragraph 6(1) to be met. That removes the possibility of HMRC contending in future that paragraph 6(2AB) was meant to operate independently of paragraph 6(1).

Schedule 2 Part 8 (the relevant company to carry on the relevant qualifying activity requirement) provides that this change does not apply to shares or securities issued before 6 April 2007.

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 63: VCT: preparing to carry on research and development (R&D) is not treated as preparing to carry on a qualifying trade: clause 300 and Schedule 2 Part 8 (meaning of "qualifying trade")

This change makes it clear that preparing for R&D is not a "qualifying activity".

Schedule 28B to ICTA explains the meaning of a qualifying holding. In paragraph 1(1):

This Schedule applies, where any shares in or securities of any company ("the relevant company") are at any time held by another company ("the trust company"), for determining whether and to what extent those shares or securities ("the relevant holding") are, for the purposes of section 842AA, to be regarded as at that time comprised in the trust company's qualifying holdings.

In the rewrite the trust company is called "the investing company".

Paragraph 3(3)(a) of Schedule 28B requires that a qualifying company must have been involved, at the time the relevant holding is issued and at all times since, in one of two activities. One is:

carrying on a qualifying trade wholly or mainly in the United Kingdom.

Paragraph 4(1)(b) of Schedule 28B provides that the carrying on of any activities of R&D is treated as the carrying on of a qualifying trade where it is intended that:

there will be derived a trade that will comply with this paragraph.

This means that the carrying on of any activities of R&D can meet the requirement in paragraph 3(3)(a).

There is no explicit guidance in paragraph 3 or paragraph 4 of Schedule 28B about preparing to carry on R&D but the interpretation of the deeming provision in paragraph 4(1)(b) has been that it does not extend to the second leg of the requirement in paragraph 3(3). Paragraph 3(3)(b) refers to:

preparing to carry on a qualifying trade which at the time when the relevant holding was issued was intended to be carried on wholly or mainly in the UK by a qualifying company.

This interpretation is well known. For example the guidance material in paragraph 17020 of HMRC's Venture Capital Schemes Manual states that:

preparing to carry on research and development does not count as preparing to carry on a trade for the purposes of ICTA88/Sch28B/Para 6.

(Paragraph 6 of Schedule 28B imposes further tests of an activity that meets the requirement of paragraph 3(3).)

In the enterprise investment scheme (EIS) and the corporate venturing scheme (CVS) the position is clearer. For EIS section 289(2)(b) of ICTA deals with R&D and in contrast to section 289(2)(a), which covers the carrying on of a qualifying trade, there is no mention of preparations. The venture capital trust (VCT) scheme was intended to follow EIS in this respect.

In paragraph 25(2) of Schedule 15 to FA 2000 (CVS) there is a deeming provision similar to the one in VCT. The final line states:

but preparing to carry on such activities does not count as preparing to carry on a qualifying trade.

In practice there is an uncertain distinction between R&D and preparation for R&D but it seems sensible to put this matter beyond doubt and match VCT with EIS and CVS.

Clause 300(2), (which is subject to Change 41) states:

The carrying on of any activities of research and development from which it is intended-

    (a)     that a trade will be derived which-

    (i)     will be a qualifying trade, and

    (ii)     will be carried on wholly or mainly in the United Kingdom, or

    (b)     that a trade will benefit which-

    (i)     is or will be a qualifying trade, and

    (ii)     is or will be carried on wholly or mainly in the United Kingdom,

is to be treated as the carrying on of a qualifying trade.

Subsection (3) uses the same wording as that quoted from the CVS paragraph 25(2):

but preparing to carry on such activities does not count as preparing to carry on a qualifying trade.

In Part 6 of this Bill (VCT) clause 300(3) states explicitly that preparing to carry on R&D does not count as preparing to carry on a qualifying trade. And paragraph 3(3) of Schedule 28B to ICTA is rewritten in clause 291(1) to (3) in terms of a qualifying activity. Within this new label the carrying on of any activities of R&D falls within the carrying on of a qualifying trade in clause 291(2). R&D cannot be included in subsection (3) of that clause, which caters for preparing to carry on a qualifying trade.

 
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Prepared: 8 December 2006