State aid SA (2011/N) United Kingdom Amendments to the Enterprise Investment Scheme (NN 42a/2007 and NN 42b/2007)

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1 EUROPEAN COMMISSION Brussels, C(2011)6477 final Subject: State aid SA (2011/N) United Kingdom Amendments to the Enterprise Investment Scheme (NN 42a/2007 and NN 42b/2007) Sir, 1. PROCEDURE (1) By letter dated 20 July 2011, registered at the Commission on the same date, the UK authorities notified, according to Article 108 (3) of the Treaty on the Functioning of the European Union (TFEU), some modifications to existing aid NN 42a/2007 and NN 42b/2007 1, consisting of three different risk capital schemes ("Enterprise Investment Scheme", "Venture Capital Trusts" and "Corporate venturing Scheme"). The modifications concern only the Enterprise Investment Scheme. 2. CONCISE DESCRIPTION OF THE AID MEASURE AND OF THE NOTIFIED AMENDMENTS TO THE ENTERPRISE INVESTMENT SCHEME (2) On April 2007, the UK authorities introduced an aid measure approved by the Commission under decision NN 42a/2007 and NN 42b/2007 in order to encourage private individuals and companies to invest in small, unquoted, high growth-potential companies in the UK. 1 Approved on 29 April 2009, OJ C 145, , p. 6. The Rt Hon William HAGUE Secretary of State for Foreign Affairs Foreign and Commonwealth Office King Charles Street London SW1A 2AH UNITED KINGDOM Commission européenne, B-1049 Bruxelles/Europese Commissie, B-1049 Brussel Belgium Telephone: (0)

2 (3) The aid measure consisted of three different risk capital schemes: (a) Enterprise Investment Scheme (EIS); Venture Capital Trusts (VCT); Corporate Venturing Scheme (CVS). The EIS and VCT schemes are still in force until 6 April 2013, while the CVS scheme ended on 31 March Only the EIS scheme is subject to the present notification. (4) According to the EIS scheme, tax benefits are accorded to private individuals (natural persons) who are liable to UK income tax, not necessarily resident in UK, who must be independent from the company issuing the EIS shares. The tax incentives are the following: Income tax relief at 20% of the amount invested in new full-risk ordinary shares in qualifying companies (up to a maximum of the individual s pre-eis income tax liability). Relief is given for investments of up to GBP 500,000 per year, per investor at the conditions set in the Commission's decision. Shares must be held for at least 3 years. Relief from capital gains tax on gains from shares that have qualified for income tax relief (set out above) and which are disposed of after at least three years. Capital gains tax deferral. Where the investor has made a taxable capital gain on the disposal of any other asset, the tax charge arising on this gain can be deferred if the gain is invested in shares under EIS. (5) Furthermore, investments can be made through collective investment vehicles, whose managers invest on behalf of investors in a portfolio of qualifying companies. There is no specific residence requirement regarding EIS funds' establishment. (6) Qualifying companies receiving investments through the schemes in force (EIS and VCT) are subject to an annual investment tranche limit of GBP 2 million. (7) The notified amendments to the "Enterprise Investment Scheme" are as follows: (i) Increase in the rate of income tax relief. It is proposed to increase, as from tax year 2011, the rate of income tax relief available to EIS investors from 20% to 30%. According to the UK authorities, the rate of income tax relief (20%) currently available under the EIS scheme is not appropriate to compensate for the high levels of risk and due diligence costs that are associated with direct investments into relatively new companies with little track record or detailed business plans, and is not compensated by the additional capital gains tax benefit granted to EIS investors, who are typically business angels investing relatively small amounts in high-risk, high growth potential companies (either directly or through small informal networks); (ii) Increase the annual investment limit. It is proposed to increase, as from 6 April 2012, the annual investment threshold for individuals from GBP 500,000 to GBP 1,000,000. This change would enable target companies to access significant levels of growth capital from a manageable number of business angels up to the limit of the annual investment tranche per qualifying company (GBP 2 million). 2

3 (8) According to the UK authorities, after the initial take-up phase, the EIS scheme has declined in use over the period and remained fairly static until 2008, when a further decline was observed. Although some decrease in its use can be due to the economic downturn, the said decline cannot be attributed to the VCT scheme, which has remained stable following the introduction of a 30% tax relief. The current relatively lower use of the EIS can rather be explained by the fact that the relevant investments are made directly into new companies with little track record or detailed business plans, thereby implying relatively high costs of due diligence on the investor 2. The envisaged modifications would thus ensure a more proportionate level of relief, relative to the high risk profile of invested companies, which in turn would encourage additional levels of investment through the EIS scheme as shown by the results of the public consultation on the UK Government s Access to Finance Green Paper 3. Therefore, the modification of the scheme would be necessary to reach its objective, and should result in a net increase in the availability of risk capital. Furthermore, the increase in the EIS rate of income tax relief would bring the scheme into line with the VCT scheme, thus providing parity of relief between direct and intermediated investments without leading to a displacement of investment from the VCT because the two schemes are targeted at different types of investor. (9) In addition, the UK authorities intend to prolong the scheme, as amended, until 5 April 2016, thus extending the duration of the scheme concerned by additional 3 years. (10) The estimated loss of tax revenue stemming from the tax incentives of the aid scheme, including the proposed amendments, amount to GBP 980 million in total during the 5 years concerned (April 2011 April 2016). Out of this amount, the budgetary impact of the proposed amendments is estimated to be GBP 360 million. (11) All other elements and conditions of the previously authorised aid NN 42a/2007 and NN 42b/2007 are maintained Legal basis (12) The legal basis is the Income Tax Act (ITA) 2007 as lastly amended by the Finance Act 2011 (clause 42) for the increase in the rate of income tax relief (30%) as from April For the increase in the annual investment limit (GBP 1 million), starting from April 2012, the legal basis is the Income Tax Act (ITA) 2007 as it will be amended by the Finance Bill 2012, once approved. (13) In both cases, the legal basis contains a standstill clause providing that the measure will not enter into force prior to the Commission's approval. 2 3 According to data submitted by the UK authorities, the average EIS investment into a company was in approximately GBP 273,000 and the average individual investment was GBP 22,000. The same information indicates that due diligence costs are estimated to range between GBP 20,000 and 50,000 for straightforward deals. Such costs therefore represent a significant share of the EIS investments. 3

4 3. ASSESSMENT OF THE MEASURE 3.1. Legality (14) By notifying the scheme before the implementation of the amendments, the UK authorities have fulfilled their obligation according to Article 108(3) of the TFEU Existence of aid within the meaning of Article 107(1) of the TFEU (15) The approved aid measure (NN 42a/2007 and NN 42b/2007) was found by the Commission to constitute State aid, within the meaning of Article 107(1) of the TFEU. (16) Through the notified amendments the UK authorities intend to accord individual investors a stronger incentive for eligible investments under the EIS scheme. The combined effects of the two modifications described in points (i) and (ii) of paragraph 7 might encourage individuals to increase their direct investments into target companies. These investments are financed through tax incentive, granted by the State, thus constituting State resources. (17) The tax advantages from the State tend to strengthen the positions of these enterprises in relation to their competitors in the European Union and therefore have potentially distortive effects on competition. Target companies' activities are or might be subject to intra-eu trade and therefore the aid is likely to affect trade between Member States. (18) Consequently, the changes introduced by the notification do not alter the conclusion of the Commission in case NN 42a/2007 and NN 42b/2007, that the measure constitutes State aid within the meaning of Article 107(1) TFEU Compatibility of the aid (19) The Commission has assessed whether the proposed modifications affect the compatibility of the aid measure with the Community Guidelines on State Aid to promote risk capital investments in small and medium-sized enterprises (hereinafter: RCG4), which specifies the general provision of Article 107(3)(c) of the TFEU in the field of risk capital measures to SMEs. (20) In its previous decision NN 42a/2007 and NN 42b/2007, the Commission found the aid measure compatible with the common market, considering all the elements of each scheme in line with the compatibility criteria set by the RCG. These elements have not been modified by the amendments subject to the present notification. In particular: Level of investment tranches. The annual limit of GBP 2 million per qualifying companies, which when the Commission originally assessed the approved aid measure (NN 42a/2007 and NN 42b/2007) exceeded the limit set by point of the RCG (EUR 1.5 million) and required a detailed assessment under point 5.1(a) of the 4 OJ C 194, , p. 2. 4

5 guidelines, now remains within the limit of EUR 2.5 million laid down under point of the RCG, as recently amended 5 ; Restriction to seed, start-up and expansion financing. The aid measure provides, pursuant to point of the RCG, financing to small and micro enterprises including their expansion stage, excluding buy-outs and replacement capital. The stages of eligible investments have not been modified by the present notification ; Prevalence of equity and quasi equity investment instruments. The aid measure provides, in line with point of the RCG, at least 70% of its total budget in the form of equity and quasi equity investment instruments into target companies. This point has not been subject to any changes; Participation by private investors. The aid measure ensures that more than 50% of the funding is provided by private investors in compliance with point of the RCG; Profit driven character of investment decisions. In line with point of the RCG, decisions to invest into target companies are profit-driven because of: (1) the significant involvement of private investors is ensured by the fact that all of the capital delivered through the schemes is provided by private investors; (2) the existence of a business plan and of an exit strategy, considered both as pre-requisites for funding. The profit-driven character of investments remains unchanged. (21) On the basis of the above, the amendments to the EIS scheme, described in points (i) and (ii) of paragraph 7 above, as well as the budget increase and the prolongation of the duration of the measure, do not have any impact on the assessment of the approved aid scheme under Chapter 4 of the RCG. In addition, the Commission notes that the UK authorities have provided further proof of the necessity of the measure as described in paragraph 8 above. (22) In view of the above, the Commission sees no reason to depart from its previous positive compatibility assessment in case NN 42a/2007 and NN 42b/2007 and concludes that the aid granted under the EIS, as amended, meets the relevant provisions of the Risk Capital Guidelines. 4. DECISION (23) The Commission concludes that the notified State aid measure SA (N/2011), amending the Enterprise Investment Scheme, is compatible with the internal market, pursuant to Article 107(3)(c) of the TFEU. The Commission decides accordingly not to raise objections to the notified measure. (24) The Commission reminds the UK authorities that, in accordance with Article 108(3) of the TFEU, all plans to refinance, alter or change this aid scheme have to be notified to the Commission. (25) The Commission further reminds the UK authorities to submit annual reports on the implementation of the notified aid scheme, as amended. 5 Communication from the Commission amending the Community guidelines on State aid to promote risk capital investments in small and medium-sized enterprises, OJ C 329, , p. 4. 5

6 If this letter contains confidential information, which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of the letter in the authentic language on the Internet site: Your request should be sent by registered letter or fax to: European Commission Directorate-General for Competition Directorate for State Aid State Aid Greffe B 1049 Brussels Fax No.: Yours faithfully, For the Commission Joaquín ALMUNIA Vice-President 6