"Dear Kathryn and Des
I read the attached guidance notes with interest. I am sure that you will receive a chorus of responses saying the same thing, which is that it is a bad idea to take the advance assurance away where there is some reason to think the disqualifying arrangements rules may be in point. As you were kind enough to bounce an earlier draft of the legislation off me, I hope you will not mind me adding my thoughts in a separate e-mail outside of any more formal response.
My constructive suggestion for what you might do instead is set out at paragraph 4 below, in case you wish to read that first(!)
1. The substantive guidance is quite short and really just repeats the legislation for conditions A and B.
I was hoping to see something more concrete. It would be helpful to have some examples of where HMRC think the disqualifying arrangements rules do and do not catch structures. Perhaps this will come later? If more detailed guidance is to follow, it would be helpful to make that clear when this initial guidance is published. We have some hints through the hallmarks in the advance assurance guidance, as to which see further below.
2. Advance assurance has proved vital to making EIS work in practice and refusing to give a concrete decision in any context is (I believe) a mistake.
The EIS rules are (too) complex and include a number of anti-avoidance provisions, now including the disqualifying arrangements rules. The disqualifying arrangements rules are widely drafted and, frankly, it is not always easy to see if a given business proposition is in or outside the intended mischief. I have until now been relaxed about this because I have considered that taking guidance and the advance assurance process together it would always be possible to achieve certainty in real time.
3. Lack of final decision on an advance assurance application creates unnecessary uncertainty and will penalise some industries more than others
Advance assurance can only be binding on HMRC if full disclosure is made. It seems to me that HMRC would be better off either giving advance assurance because HMRC is content that the disqualifying arrangements do not apply or refusing it because HMRC considers that the disqualifying arrangements provisions do apply. In other words, make a decision one way or the other and don't leave the taxpayer hanging.
If HMRC does not have enough information to make a decision, HMRC is entitled to ask for more information. HMRC is also entitled to caveat any advance assurance as being based on the assumption that the project will be implemented as described. If any applicant for advance assurance proves to be economical with the truth, HMRC is entitled to refuse to honour the advance assurance.
I therefore do not see what policy protection a refusal to give a firm decision on an advance assurance will give.
I tell clients that EIS relief is only available in practice if HMRC agree that it's available, but that we can ask in advance whether HMRC agree. I think this is a good place to be - it discourages people from pushing the envelope with EIS structures whilst supporting the investment at which EIS is aimed.
It seems to me that refusing to give a decision under the advance assurance process in relation to the disqualifying arrangements rules will have a number of impacts, for example:
(a) People will implement structures which they consider to be outside the rules, and HMRC will sometimes disagree after the fact. It is in the nature of tax that the edges of any relief will be tested. Advance assurance gives HMRC considerable control over those edges.
After the fact refusal to grant EIS relief will cause disputes, which have generally been rare in the EIS context because of the advance assurance process. It is generally too late for investors to get their money back after the event, and so there is also potential for causing disputes between investors and the company in which they invest. In practice, a refusal to give a decision on an advance assurance is likely to kill some projects which should have gone ahead and cause some project to go ahead which should not have done.
(b) There will be a period of significant uncertainty where the true scope of the rules will not be clear, and this may adversely impact the ability of companies in particular industries to raise EIS funds. As you know, I have an interest in the media sector. Entrepreneurial companies in the media sector will often bear some of the hallmarks which HMRC refer to in this guidance, including:
(i) raising funds with the assistance of a third party intermediary
(ii) trading activity (e.g. film production) not commenced when funds raised
(iii) involvement of non-employees
(iv) return deferred compared to expenditure (because the return comes after the film is made and released)
Although the nature of film assets has led some promoters to undertake loss generating schemes which HMRC does not like, in the EIS context this can and should not be possible. HMRC has gone to some length to reassure the media industry that EIS is available for appropriate business opportunities. The disqualifying arrangements rules enable HMRC to ensure that EIS is not available for inappropriate opportunities. The proposed new guidance on advance assurance will, I am sure, be taken by those in the media industry as evidence that HMRC does not mean what it says in this context, and that EIS is in practice never available for media businesses.
There was a list of hallmarks in the original consultation document on disqualifying arrangements. In light of the feedback received on that consultation, HMRC moved to a qualitative description of disqualifying arrangements coupled with a purpose test, which is much much better. Denying a decision on advance assurance by reference to a very similar list of hallmarks is just bringing back the problem which the original list created through the back door?
4. Stop complaining and suggest something constructive
It is helpful for HMRC to give an indication of where the disqualifying arrangements rules will be considered in relation to an application for advance assurance. It would also be helpful for HMRC to specify the information and level of detail which HMRC will require before making a decision on an advance assurance application.
I therefore think it would be appropriate for HMRC to tell taxpayers that there are particular hallmarks which will lead HMRC to consider carefully whether the disqualifying arrangements are in point, so that the level of detail required in relation to an advance assurance application will be higher than if those hallmarks were not present. HMRC can require that applications for advance assurance consider and explain the extent to which any of the identified hallmarks are present. So, for example in the context of a film production company seeking equity funds for a new production:
(a) The advance assurance application would set out the legal and economic structure in detail - who are the parties, how is the film produced, how is it financed, how will it be exploited, who will own the rights, what rights will the EIS company acquire, what rights will the EIS company grant, etc.;
(b) The advance assurance application would identify specifically:
(i) if a third party intermediary is involved in raising the funds, and if so who and on what financial terms (goes to main purpose of arrangements)
(ii) if the company will not commence trading until after the EIS funds have been raised (I'm not sure why this is relevant? - main purpose?)
(iii) if the company will engage independent contractors to make the film (with additional detail about what is intended) or will sub-contract any of its obligations to a third party (goes to Conditions A and B)
(iv) the financial arrangements - when and how will the company spend the EIS money and how will it make a return (goes to Conditions A and B), how will the EIS investors recover their investment, what are the financial implications for EIS investors, what is the likelihood of profit or loss for EIS investors?
(vi) any references to the risk of the project set out in the investment memorandum (goes to Condition B in particular)
I would expect all of this information to be in a well put together application for advance assurance in any event. If this information is available to HMRC in an advance assurance application, why can't HMRC just give a "yes" or "no" answer?
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