Non-qualifying activities in VCT investees

In the past HMRC have been comfortable with companies that have attracted VCT investment then going on to have non-qualifying activities of up to 20% of their total activities. The measure of ‘activities’ has been interpreted quite widely but as a rule of thumb such companies have been advised to keep their non-qualifying activities as less than 20% of their turnover, assets, headcount, floorspace, etc. If the 20% limit was breached for any measure there was a risk that the non-qualifying activities would taint the VCT qualification status of the investment.

This has now changed in a way that is unhelpfully unclear. When this was tested in litigation with HMRC, it was decided that as the wording in the legislation is ‘substantial’ and doesn’t refer to ‘20%’, the 20% rule has no basis in law and can’t be relief on. This is a great example of how, just because something is in the HMRC manuals as their published practice, it can’t be relief on if it doesn’t follow the law. HMRC’s interpretation of the law isn’t binding. Although this can be frustrating (as in this case), over the years this point proves to be useful more times than not.

So where does this leave us? What is or is not ‘substantial’ in terms of a business’s overall activities is not yet well defined (just saying substantial refers to something which isn’t insubstantial doesn’t tell us much) and it will take several years for any real confidence to build up around that point. In the meantime, investors tend to rely on caution and steer clear of investments that stray into the grey area too much. For our part we see this as running counter to the intention of the tax relief which is to encourage investment and so we hope to see some useful clarity on this issue sooner rather than later, to help businesses flourish and to take advantage of the commercial opportunities which lie ahead.

In an ever-changing world, businesses need to be agile and should be able to act with certainty about the tax framework that they operate within.