The government is to consult on a new Enterprise Investment Scheme (EIS) fund structure offering investors a dividend tax exemption.
The proposal, outlined by chancellor Philip Hammond in his Spring Statement, follows the launch of the government's Patient Capital Review in November 2016.
Despite its recent efforts to boost investment in EIS, the government wants to explore why some 'knowledge-intensive' firms are unable to obtain the levels of funding they need to be successful.
The new structure would build on existing EIS rules, focusing almost entirely these knowledge-intensive companies in a bid to experience inflows into this area.
Qualifying investments would be required to have met at least one of two conditions:
* To have spent at least 15% of operating costs on R&D or innovation in one of the three years preceding investment
* To have spent at least 10% of operating costs on R&D or innovation in each of the preceding three years.
On top of this, companies are required to provide evidence of creating, or recently creating intellectual property.
Dividend tax relief
One option to help boost inflows that the government is proposing is a dividend tax exemption for those investors remaining loyal to knowledge intensive firms over the long term.
'A "patient" dividend tax exemption could be applied in respect of investments made through a knowledge-intensive fund,' the Spring statement said.
'Investors would not pay tax on dividends received from knowledge-intensive investee companies after a fixed holding period.'
An exemption could last between five to seven years, the government added.
'[This] would encourage and reward patient investment. However the rules would need to address the risk that companies could be pressured into issuing dividends before they are making adequate profits, instead of reinvesting profits into the growth of the company.
'A dividend exemption effective only after a given period would fit well with the objective of encouraging patient investment.
'However there is a question about whether it would be effective at motivating additional investment given some stakeholders identify the potential for large capital gains, rather than an income stream, as the primary motivation for investment in high growth companies.'
It added that a small proportion of investments of up to 20% could be invested in non-knowledge-intensive EIS companies.
'The government anticipates that any new knowledge-intensive fund would be subject to HMRC approval,' the statement read.
'This would place a compliance obligation on fund managers, although the precise extent of this would depend on the incentives attaching to the fund and the way in which tax relief is given.'
The latest initiative comes after the chancellor doubled the EIS investment threshold for knowledge investment firm to £2 million in his Budget last November.
EIS manager Deepbridge Capital applauded the new move to finance growth in innovative firms.
'As an investment manager that utilises EIS to almost solely support knowledge intensive companies, Deepbridge welcomes any move by the government to further support the digital, technology and life sciences economies.
'It is positive to hear that the chancellor continues to emphasise his support for the Enterprise Investment Scheme, with a particular focus on innovation and job creation.'
Alex Davies, founder of Wealth Club which specialises in tax-efficient products for high net worth investors, also welcomed the move, but warned the government against making the system too complicated.
'Anything that encourages investment in potentially world beating companies and gives us more businesses like Dyson, ARM Holdings and Abcam can only be a good thing,' Davies said.
'The one thing the government should avoid at any cost in my opinion is to introduce further complexity. However good the government’s intentions, and however great the benefits, if the rules are too complex investors will be put off.'