By Peter Mayhew, legal director in the investment funds team at law firm, Shakespeare Martineau
Having now officially left the European Union, there are many mechanisms within the business world that will change over the coming months and years. One which will be of particular interest to many fast-growing, ambitious companies is the mechanisms with which the UK regulates state aid in future, now it is free from EU control. But in a system that is complex by its very own nature, what changes lie ahead and is there an opportunity for the UK to refine state aid subsidies to its advantage?
State aid – or subsidy control as it is more appropriately referred to post-Brexit – is an umbrella term given to various forms of financial assistance provided by a public body to a private business, which carry the risk of distorting competition in the wider marketplace. A wide range of financial support mechanisms from subsidies and grants, right through to tax-advantaged venture capital schemes such as VCT, EIS and SEIS, all fall under the banner of state aid subsidies.
Prior to the UK’s exit from the EU, state aid subsidies were governed by a number of EU laws, including the General Block Exemption Regulation (GBER), which aimed to monitor and control Member States when giving state aid. Now however, the UK is no longer required to so closely abide by those regulations and an opportunity lies ahead to formulate a new system, which may be more advantageous for UK business.
On 31 March 2021, a consultation led by Business Secretary Kwasi Kwarteng closed, which asked the UK business community for their thoughts around what a new subsidy control system could look like for the UK and what improvements could be made.
In the past, there have been tensions between HM Treasury and the European Commission, when, during audits, the UK was found to be administering the venture capital schemes in a manner which wasn’t fully-compliant with the black letter and/or spirit of GBER.
There were several areas in particular where the UK’s assessment had fallen short, for example permitting the use of tax advantaged monies pursuant to the venture capital schemes for the acquisition of businesses and allowing more mature and established businesses to receive funding than the EU rules might have permitted. Although a reversal of the ‘no acquisition’ rule might be wishful thinking, the company age test could be a potential candidate for change under a new post-Brexit subsidy control system.
The company age test, in particular, can be restrictive to those companies seeking EIS/VCT eligibility. Generally speaking, it requires the investment to be made within seven years of their first commercial sale (ten years if the company is considered ‘knowledge intensive’). If they have previously received state-aided investment then there is some scope to rely on a ‘follow-on funding exemption’ but those rules are more restrictive than they might appear at first blush. The application of the ‘age test’ has, however, caused problems even for companies which on the face of it would fall well within the age limits. This is due to the fact that even the most innocuous of business or asset acquisitions can taint the company’s age. For example, it is not uncommon for a founder to bring with him some intellectual property or asset from a prior business endeavour. Depending on the materiality of the acquired asset and, if it has generated any revenue – no matter how small – in the past, then the age of the prior business to which that asset was originally attributed risks being considered as that of the company, resulting in an otherwise startup business being technically excluded from the schemes.
These outcomes are unfortunately a product of legislation which was designed at the time to avoid artificial structuring and abuse, an approach which might be viewed in the context of stringent compliance with EU state aid rules. In a future system, relaxing some of the parameters of this test to avoid some of these absurdities would be helpful.
Luckily now, whilst the UK must still have a subsidy control mechanism in place which aligns with EU regulation, there is room for a more creative approach with the UK being able to set its own rules subject to broadly aligning with the EU rules. Whilst we anticipate that the current setup of the venture capital schemes will remain largely unchanged and continue to function as intended under the re-focussing of the rules for EU compliance, certain tweaks and refinements around the edges would be useful and could smooth out some of the snagging points currently created by the EU’s rules. In this regard refining the company age test would be a good place to start.
Ultimately, it’s unlikely that the ongoing consultation will bring about any radical changes, at least in the immediate future and whatever changes are introduced should keep the original aim of state aid in mind, providing a net benefit and continuing to foster a culture of innovation and enterprise. Although the government will be establishing a separate body, with the sole responsibility of managing state aid, when this will be, what this will look like and what exact responsibilities it will have, remains to be seen.
State aid and the various schemes that fall under its banner, are some of the most important finance mechanisms we have. They promote investment, provide support to interesting and fast-moving companies and ensure a healthy flow of capital through the market. Whatever changes the UK decides to embrace in future, it’s essential that venture capital schemes continue to play a part in that.