VCM12100 - The investment process: employment of money: company using it

ICTA/S289 (1A) - (1E); ITA/S183; ITA/S294; TCGA92/SCH5B/PARA1 (2)(e)

EIS and VCT scheme: share issues before 17 March 2004

For EIS and VCT share issues before 17 March 2004 a company which uses any of the money raised by an issue of shares (called an 'active company' in the EIS legislation and a 'trader company' in the VCT scheme legislation) must be one of the following:

• a company which exists for the purpose of carrying on a qualifying trade (disregarding any purpose concerned with holding shares in subsidiaries, making loans to other group companies, and holding and managing property used by any group company for a trade or for research and development), or
• a subsidiary company which exists for the purpose of holding and managing property as described above.

If the company employing the money is a subsidiary, it must be a 90% subsidiary (EIS) or a relevant qualifying subsidiary (VCT). In each case the essential requirement is that the issuing company directly or indirectly owns 90% of the issued share capital in the subsidiary. (See VCM15060 for details of ownership criteria in cases in which a company has subsidiaries that are not active companies.)

For the EIS this rule must be satisfied throughout the three year period, while for the VCT scheme it must be satisfied at any time when the status of the VCT's holding in the company is being considered.

EIS and VCT scheme: share issues on or after 17 March 2004

These ‘active company’ and ‘trader company’ rules were removed for shares issued on or after 17 March 2004. From that time the requirement is that the activities for which the money was raised must be carried on by the company that raised the money or any qualifying 90% subsidiary of that company. There is no longer a requirement that the same company must carry on the trade throughout. This change gives investee companies scope for moving a trade around a group without jeopardising investors’ reliefs.

Note that for these post FA04 rules the level of ownership of the subsidiary that must be achieved by the issuing company remains 90%, but the company must directly own the shares of the subsidiary.

For EIS these replacement rules provide that at no time during the relevant period must relevant preparation work, the qualifying trade or relevant research and development be carried on by someone other the qualifying company or one of its qualifying 90% subsidiaries. But the rules do not act to deny relief where an existing trade is carried on by another company and the issue of shares is preparatory to the carrying of a qualifying trade by the qualifying company or one of its qualifying 90% subsidiaries. A ‘hive up’ - see VCM12070 - is no longer necessary. Neither do the replacement rules act to deny relief in cases in which the qualifying company (or any other company) goes into liquidation, administration or receivership provided that these actions are entered into and carried out for bona fide reasons and that the relevant qualifying trade is not sold on a going concern basis to a person who was connected with the qualifying company during the period of restriction.

Similar provisions apply to share issues by VCTs that take place on or after 17 March 2004. If the ‘relevant company’ (the company in which the VCT invests) does not exist wholly (disregarding any incidental purposes) for the purposes of carrying on a qualifying trade, and is not carrying on such a trade or preparing to do so, then these criteria must be satisfied by a qualifying 90% subsidiary of the investee company. As for EIS, the rules above relating to liquidation, administration or receivership apply.

Prior to FA04 a group of companies that raised money for an activity carried on by a subsidiary of a subsidiary could fall within the EIS and VCT schemes. The direct ownership requirement introduced by FA04 for qualifying 90% subsidiaries and relevant qualifying subsidiaries would disqualify such companies in respect of any further share issues that take place on or after 17 March 2004. However there is a solution: the parent company arranges for the transfer of its subsidiary's shares and securities in the trading company to itself, thereby making the trading company a direct subsidiary of the parent, before the parent company issues further EIS shares.

The same solution can be applied when a company which has issued shares before 17 March 2004 then undertakes an exchange under ICTA/S304A prior to issuing further EIS shares.

Where companies with a trading subsidiary who first issue EIS shares on or after 17 March 2004 subsequently make use of ICTA/S304A or ITA/S247 prior to issuing further EIS shares the same solution can be applied. But there are other options. Because of the abolition of the active company rule by FA04, the trading subsidiary could transfer its trade to its parent before the parent embarks on the Section 304A or Section 247 exchange. Alternatively, the new holding company could immediately create another 90% qualifying subsidiary, and the trading company could transfer its trade to that company.

CVS

Prior to FA04 the activities for which money was raised by a CVS investee company could be carried on by the issuing company or one of its 75% subsidiaries.

For shares issued on or after 17 March 2004 those activities must be carried on by the issuing company or one of its qualifying 90% subsidiaries (ownership of which must be direct).

EIS, CVS and VCT share issues on or after 6 April 2007

FA07 relaxed the rule that, if a qualifying trade was carried on by a subsidiary of the company issuing the shares, that subsidiary had to be a directly owned 90% subsidiary. From 6 April 2007 the company carrying on the trade can also be a 100% subsidiary of a directly owned 90% subsidiary, or a 90% subsidiary of a directly owned 100% subsidiary.

It should be very rare that a group would find itself in a position where the company carrying on the qualifying trade is not a company covered by this relaxation. But if this should arise the group can meet these requirements by restructuring itself along the lines suggested above.