Artificial intelligence and big data, healthy ageing, clean growth, and future mobility are all sectors in which advanced economies are jockeying for supremacy. With a number of new knowledge intensive EIS funds entering the UK market, Harriet Doherty from Parkwalk, looks at the landscape for these tax-friendly investments and the qualifying conditions for companies.

This article was published in Wealth Briefing.

Why is the government so keen on ‘Knowledge Intensive’ companies?

Last year the Prime Minister announced that the government wanted to create a ‘science superpower’ but this rhetoric was already set-in motion by the previous government when Theresa May announced the current modern industrial strategy for the UK.

The previous Prime Minster stated at the time: “We are ranked first in the world for research into the defining technologies of the next decade, from genomics and synthetic biology, to robotics and satellites,” said May. “With one per cent of the world’s population, we are home to 12 of the top 100 universities.”

Highlighting once again the UK’s position as a global leader in innovation and research and development (R&D). In particular, the then Government wanted to address four grand challenges: Artificial intelligence and big data, healthy aging, clean growth and future mobility.

And EIS and VCTs were very seen as part of the solution, especially post Patient Capital review, and effective from April 2018 EIS and VCT fund managers have been able to take advantage of ‘Knowledge Intensive’ qualifying status.

The present government has doubled down in this area and in the 2020 budget the government announced a huge increase in the R&D budget to £22bn per year. As well as the launch of a new Knowledge Intensive EIS Fund initiative, again highlighting how important EIS is seen in backing government’s grassroots R&D investment to help put the UK in a strong position to tackle many of the world’s challenges, as well as delivering growth to UK plc in a post Brexit world. 

The recent rollout of the ‘Oxford vaccine’ only increased the view of how important Research & Development (R&D) will be in tackling the greatest challenges faced by humanity. It is Knowledge Intensive businesses whose years of work goes on to underpin the greatest leaps in mankind.

What is a Knowledge Intensive Company (‘KIC’)?

Both EIS and VCTs can take advantage of the expanded investment benefits of investing in KICs at investment level, although added benefit for ES investors.

In broad terms, a KIC is a company that spends a significant amount on research and development and innovation, with a focus on developing intellectual property (IP).

Firstly,  KIC must spend at least 15% of its operating costs on R&D or innovation in one or more of the previous three years, or at least 10% in each of the previous three years.

In addition, the company must meet either an ‘innovation’ or ‘skilled employee’ condition. The first, requires a company to create intellectual property (IP). To pass the latter, at least 20% of a company’s employees must hold postgraduate degrees and be engaged in R&D. 

Naturally, these conditions for KICs lend themselves well to science and tech-based companies that have spun out of academic institutions, for example companies focused on deep-tech, life sciences or AI driven businesses, underpinned by strong intellectual property.

What are the different allowances for KICs?

In terms of funding, KIC businesses can raise up to £10 million a year (instead of £5 million) and then £20 million (instead of £12 million) over their lifetime (EIS and / VCTs) and are allowed a maximum of 500 employees (versus 250 maximum for non-KIC).

Another advantage is that the age limit for KICs is a lot higher, with typically EIS companies only allowed to receive funding within 7 years of their first commercial sale, whereas for KICs this period is extended to 10 years.

And for big investors the EIS allowance effectively doubles to £2 million, provided anything over £1 million is invested in KICs.

What is a Knowledge Intensive EIS Fund?

The overwhelming feedback to HM Treasury when they were reviewing changing the old ‘HMRC Approved EIS Funds’ to focus them on KICs was to create a cleaner EIS fund structure. So, KI EIS Funds only have one tax certificate (an EIS5) and there is certainty around when to claim income tax relief.

These new funds are approved by HMRC giving investors the option of whether to claim income tax relief either in the year the fund closes, or carry back to the previous tax year. For Knowledge Intensive Funds closing by 5th April 2021, investors will be able to claim income tax relief for 2020/21 or have the option to carry back to 2019/20 – very useful for advisers fielding last minute calls from clients looking for carry back.

There are a few details, however, to be aware of when advising on a Knowledge Intensive Fund, one is the timings of receiving the tax certificate itself. Unlike a regular EIS fund, the EIS5 form can only be sent out to investors once a KI fund is approx. 90% deployed into KI qualifying companies, which in practice may be around 12 months after the fund closes.

Advisers also need to be aware of the difference in how capital gains tax deferral and IHT is treated, both are linked to when the KI fund invests into the underlying companies, and not linked to the fund close date.

In addition, at least 80% of funds raised in an approved EIS fund structure must be invested into knowledge intensive companies within 2 years of the fund closing. So, when reviewing this funds one must focus on fund manager deal flow of KICs.

Who are the KI EIS fund managers?

Currently there are three KI EIS funds that have been announced, including our Parkwalk EIS Knowledge Intensive Fund. Given intellectual property is a key metric for knowledge intensive companies and it comes as no surprise that the EIS leaders in the market who already focus on investing in IP backed businesses, have now launched Knowledge Intensive EIS Funds.

For Parkwalk launching the Parkwalk EIS Knowledge Intensive Fund is a natural progression, given we are the UK’s most active investor into university spinouts, backed by strong IP, and are very experienced in investing into knowledge intensive companies.

Companies which emerge from the university technology transfer system have typically been incubated within the university for a number of years with the research and IP developed. There is also good visibility on their patent situation and ‘freedom to operate’ which is key for pure IP – there is no debate with HMRC over KIC status.

It will be interesting to see how the market develops but with all the above in mind, the creation of the new HMRC approve Knowledge Intensive Fund structure is a positive step for the industry and will mean more funding reaching knowledge intensive companies. And investors should be attracted to tax date certainty and reduced administration, especially at this time of year.

To read the full article in WealthBriefing, please click here.

Find out more about the Parkwalk EIS Knowledge Intensive Fund please click here.