In Autumn last year, in CHF PIP! PLC v HMRC CHF PIP! PLC v HMRC, we saw what I believe was the first case to consider whether a proposed investment satisfied the Risk to Capital Condition (“R2CC condition”).
For the reasons I explain below, the case did not enhance our understanding of R2CC by a great deal.
However, the decision in another recent R2CC case, Inferno Films Limited v HMRC[1] (“Inferno Films Limited”), perhaps provides more illumination.
R2CC is a ‘gateway’ condition. This means that it needs to be satisfied before applying, and separately to, the myriad of other requirements.
The condition has two separate heads:
For further details of R2CC, then please see our detailed overview.
In CHF PIP!, HMRC had argued here that a Company, which had previously raised funds under EIS, should be refused relief. This is due to it not satisfying the relatively new R2CC. In the end, the taxpayer was unsuccessful here. This is because it was held that, although it was carrying on a trade, that trade was not carried on a commercial basis. However, this is a requirement by legislation.
As such, sadly, there is limited useful analysis as the tribunal held that the Company failed on the basis that “it is not reasonable to conclude that Pip has objectives to grow and develop its trade in the long- term” due to the fact it had already been determined that the business’ trade was not conducted on a commercial basis.
If you want more detail on this case then please see my earlier article.
Inferno was a film producer. It had purchased rights to acquire an unpublished film script for a film called The Ballad of Billy McRae. Over the course of several years, the Company had sought to raise funds in order to make the film.
In 2019, the Company issued shares in respect of which it completed and submitted form EIS1 to HMRC. After raising queries in relation to this submission, HMRC denied relief on the grounds that the project did not satisfy the R2CC.
In Inferno, HMRC argued that the issuing Company, Inferno, did not satisfy R2CC as:
The tribunal dealt with issue two first. Here, the tribunal judge stated that “the prospects of any net investment return to the investors generally… were extremely speculative… [and] depended entirely upon the commercial success of BBM…” As such, the tribunal had “no hesitation” in finding this element of R2CC to be satisfied.
Issue two required more discussion.
HMRC argued that there “were many aspects of the Appellant’s organisation of its business that pointed towards it either being a ‘single project’ company or… a vehicle through which finance was to be provided for individual projects”. HMRC’s evidence for this was that the investment memorandum “focused heavily” on BBM and there were few plans outlined for the future.
Inferno argued that HMRC were approaching the matter “in an entirely uncommercial way”. It was argued that a small film production Company must effectively cut its cloth to fit its cap. It could only make one film at a time, so it was for this reason that BBM was the feature of its promotional material. Although it would only make one film at a time, it was not a single project company as it would hopefully go on to make others. There was plenty of evidence to suggest that the Company would not ‘shut up shop’ after making the film.
The taxpayer highlighted HMRC’s common issue of ignoring ‘contracted out’ services. Of course, using flexible labour is a perfectly commercial decision (particularly in the film industry.) Indeed, in the case of CHF PIP!, the tribunal had expressly stated that “as a matter of principle, it is my view that a Company can trade by outsourcing its activities to a third party”.
The tribunal was persuaded by the taxpayer’s arguments that the Company also satisfied issue one.
As such, HMRC were ordered to provide authority to issue EIS certificates to its investors.
Taxpayers, advisers and HMRC will continue to grapple with this condition for years to come. However, these cases should highlight that it is important to review whether a project will qualify for EIS relief (even where it has successfully raised funds under it in the past).
If you have any queries about this article, EIS or Seed EIS, or tax matters in general then please get in touch.
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