The chancellor’s cuts to loss relief will hurt startups

 
Howard Flight
A FRIEND of mine responded to an invitation to a Big Society philanthropic event, “not sure I want to be associated with a group of tax evaders (previously known as philanthropists)”. I believe the event was cancelled. The foolishness of limiting tax relief on charitable giving has already been exposed; but there has been less focus on the damage to small businesses and entrepreneurial investment as a result of limiting loss relief on Enterprise Investment Scheme (EIS) investments which fail and bad loans to unquoted trading companies.

I welcomed the announcements in the 2011 Budget to increase the size of small and medium-sized enterprises (SME) qualifying for EIS relief, the amount which could be raised under EIS by a company and the total an individual could invest in any one year. The increase in the EIS income tax allowance to 30 per cent and the special 50 per cent income tax relief for investment in angel start-ups were also both very welcome. There seems little point in taking back with one hand what was given last year with the other.

The safety net of loss relief is a key consideration when making entrepreneurial investment decisions. Sadly, the failure rate for startups in the UK is high – and considerably higher than countries with smaller public sectors and lower taxation. For a wealthy EIS investor paying 50 per cent income tax, loss relief means that 35 per cent of the losses sustained are off-settable against income tax bills, in addition to the initial 30 per cent income tax credit. Limiting loss relief to £50,000 or 25 per cent of income, if greater, changes the whole risk/reward balance and can, therefore, be expected to reduce the flow of EIS investments.

Similarly, where the government wishes to encourage individuals to substitute for banks who are unwilling to lend to SMEs, the 50 per cent tax on the interest they receive and the limitation on loss relief will have the predictable outcome of reducing the amounts individuals are willing to lend to unquoted trading companies.

There is also a nasty retrospective aspect to the proposed changes. Those who made EIS investments or qualifying loans in the past did so on a risk/reward basis, which included loss relief if the loans failed. This is now to be removed after the event. I suggest the loss relief should be grandfathered.

Those earning over £150,000 pay 27.7 per cent of all UK income tax. This is a higher proportion than in any of the other developed economies. It is wrong, misleading and foolish, for – of all things – a Conservative-led government to imply that the wealthy are not paying their fair dues. Cooked-up tax avoidance schemes should clearly be outlawed, but income tax relief for charitable giving and loss relief on SME investments and qualifying loans which fail are not abusive. They have existed for good reasons and should be left alone.

Lord Flight is a Conservative peer, a businessman and chairman of the EIS Association.