One question that recurs, in the startup world, is how investments by VCs and other investment bodies affect whether you can claim tax credits under the SME scheme, which is considerably more lucrative than the large company scheme. There are basic rules for determining whether a company is an SME, and we’ve covered them before, including some mention of ownership rules, but this topic is worthy of a bit more detail.
The key concept here is autonomy.
A question of autonomy
No, nothing to do with that autonomy ;-). The main consideration, when applying for tax credits on behalf of a business which has investors, is whether the business is autonomous.
HMRC defines a business as clearly autonomous if no external, corporate entity owns 25% or more of its shares.
Private investors, e.g. angels that operate as individuals rather than using a company front, do not count towards this, unless, of course, they are somehow linked to the corporate investors. If Sequoia Capital owns 15% of your company, and Fred Destin (partner at Atlas Ventures) owns another 15% personally, your company is autonomous. On the other hand, if Atlas and Fred Destin each owned 15%, you would then be exceeding the 25% limit.
In this latter case, you would still count as autonomous, however, because Sequoia is a venture company. HMRC explicitly allows up to 50% ownership by:
- public investment corporations, and VCs,
- individuals or groups of individuals with a regular venture capital investment activity who invest equity capital in unquoted businesses (‘business angels’), provided the total investment of those business angels in the same enterprise is less than €1.25 million,
- universities or non-profit research centres,
- institutional investors, including regional development funds,
- autonomous local authorities with an annual budget of less than €10 million and fewer than 5,000 inhabitants.
So, up to 50% owned by a single group of connected professional investors, you’re still ok. If Autonomy (the company) owns 30% of your business, you are not considered autonomous. If Atlas Ventures owns the same amount, you are autonomous.
What if your company is 51% owned by such an investment corporation (or group thereof)? To take the simple case, what if Sequoia, after a couple of rounds of investment, owns 51% of your company?
Then, unfortunately, you are no longer considered autonomous. The question then becomes whether you are a linked enterprise, or a partner enterprise. That can determine whether you are still considered an SME for R&D Tax Credit purposes.
In short, your company is considered to be linked to the owner of your shares if one of the following is true:
- the other company owns more than 50% of the voting rights,
- they can appoint or remove a majority of your management team,
- they can exert a “dominant influence” over your company,
- they can indirectly achieve the above via agreements with other shareholders.
Basically, if they control your company, you are “linked”.
It’s worth noting that the linkage can also happen via an individual, if you are in the same industry. If you run a really small SME airline, and Richard Branson personally owns 51% of your company, you are linked to any other companies which he owns 51% or more of (and potentially to Virgin Airlines).
What happens then? Well, your figures are considered in aggregate. So, if you’re linked to a VC fund that manages more than €50m, you’re no longer in the SME scheme, and your tax credits become less than appealing.
There is another case to consider – one where you’re not autonomous, but the other company is not considered linked. For example, if Autonomy owns 30% of your business, you’re a partner of Autonomy, but they don’t control you, so you’re not linked.
So what happens then? Well, you may have a chance. To figure it out, multiply the shareholding by the turnover, balance and staff count of the other company. For example, if you were 30% owned by Autonomy back when they only had €10m of balance, they would only add €3m to your own balance, for the purpose of figuring out whether you’re an SME. So if you had €1m of balance, adding the two together would result in €4m, well under the SME limit.
If you had €1m of balance, and 30% owned by Autonomy when they were worth €100m, your balance aggregate would be €31m – so you would still be an SME, even though Autonomy would not be.
Finally, if you were 30% owned by Autonomy when they had €1b of balance, your aggregate would be €301m, so you would not be an SME.
A quick test! (answers at the bottom)
Have you been paying attention? If so, you should know the answer to these (you can find those at the bottom of the post 🙂 ):
- If your turnover is €10m, and you are 30% owned by a VC, are you likely to be an SME?
- If your turnover is €2m, and you are 60% owned by a VC, are you still an SME?
- If your turnover if €5m, and you are 30% owned by a €60m turnover company that’s not an investment corporation, are you likely to still be an SME?
- If your turnover is €40m, and you are 20% owned by a €1b company, are you still likely to be an SME?
It works in reverse too!
As a final thought, it’s worth pointing out that this works both ways. If your company owns more than 25% of a large company, you are considered in aggregate with that company, so even if you have zero turnover, you will still not be considered an SME.
- Yes, because the VC is exempt from the aggregation unless they own more than 50%.
- No, because the VC owns more than 50%, so you would only be an SME if the VC themselves counted as an SME (unlikely).
- Yes, because this company would add €18m to your turnover, which adds up to €23m, which leaves you under the €50m SME ceiling.
- Yes, because they own less than 25% of your company and so aggregation rules don’t kick in.
I hope you found this helpful!
If you are curious about R&D Tax Credits, Innovation Grants and Open CultureGET IN TOUCH
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