The R&D tax credits scheme for SMEs is extremely generous, offering far better savings than the equivalent scheme for large companies. But having the wrong corporate structure could put your eligibility at risk.
A company that owns between 25% and 50% of the shareholding in an SME would be classed as connected. And at this point a proportion of its employees, turnover and assets would be allocated to the SME. This is obviously an issue for companies that have, or are seeking, external corporate investment.
Fortunately, the legislation contains an exemption that applies if the investor is a venture capital company, but it does not define what a venture capitalist is.
Venture capital investment
We can take some guidance from the case of Pyreos v HMRC. Siemens had a shareholding in Pyreos of between 25% and 50%, which precluded the SME scheme from applying.
However, due to the dynamics of the relationship, Pyreos managed to successfully argue that in this instance Siemens was acting as a venture capitalist.
The tribunal observed that the provisions of the SME scheme were intended to benefit genuinely autonomous companies. So it defined a venture capitalist as a “company whose interest is in maximising the financial return on its investments in new businesses and speculative ventures”.
It decided that Siemens’ investment was venture capital in nature. Relevant criteria to be taken into consideration were:
- The company should be run as an autonomous company
- The venture capitalist should not have, or exercise, powers to significantly influence management on a day-to-day or strategic basis
- The venture capitalist should not have influence over the intellectual property generated by the company
- Documentation, and subsequent practice, should demonstrate the limited involvement of the venture capitalist
- Transactions between the companies should be on an arm’s length basis.
Innovative companies rely heavily on corporate investment in order to fully commercialise their intellectual property. However, consideration should be given to the tax implications of changes to corporate structure – with effective planning SMEs can continue to enjoy substantial R&D tax incentives.