Chapter 5: Venture capital trust dividends
2706.This Chapter rewrites the provisions exempting from income tax dividends from Venture Capital Trusts (“VCTs”). The sections are based on section 332A of and Schedule 15B to ICTA.
2707.The VCT scheme is one of three venture capital schemes (the other two being the Enterprise Investment Scheme and the Corporate Venturing Scheme).
2708.The VCT scheme is aimed at encouraging individuals to invest indirectly in unquoted trading companies. VCTs are companies listed on the London Stock Exchange and are a special type of investment trust approved for the purpose of the VCT scheme by the Inland Revenue.
2709.The exemption from income tax on dividends is one of the benefits of investing in a VCT. Schedule 15B to ICTA sets out the tax relief available on the investment in a VCT and sections 151A and 151B of and Schedule 5C to TCGA give certain reliefs from capital gains tax.
Section 709: Venture capital trust dividends
2710.This section is based on paragraphs 7 and 8 of Schedule 15B to ICTA and sets out the conditions that have to be met in order for a VCT dividend to be exempt from income tax.
2711.Paragraph 7(3)(a) refers to “ … a dividend (including a capital dividend) …”. This is rewritten simply as “a dividend”. Section 209(2) of ICTA, which sets out the meaning of “distribution”, also refers to “any dividend paid by the company, including a capital dividend” (see section 209(2)(a) of ICTA). However, the charging provision in the source legislation (see section 20(1) paragraph 1 of ICTA) refers simply to “all dividends and other distributions … which are not specifically excluded from income tax … however they fall to be dealt with in the hands of the recipient”. Likewise the rewritten charging provision charges to tax “dividends and other distributions …” (see section 383 of this Act). Given that the charging provision does not specifically refer to capital dividends and an investor is unlikely to know that he or she is receiving a capital dividend, the reference to capital dividends is omitted.
2712.The conditions for exemption relate first to the dividend (subsection (2)), then to the investor (subsection (3)) and then to the circumstances surrounding the investment (subsections (4) to (7)).
2713.The exemption applies only to dividends paid on ordinary shares acquired within the annual acquisition limit of £200,000 (see subsection (4)). The value applied is market value as defined in section 272 and 273 of TCGA (see subsection (8)).
2714.The condition contained in subsection (6) is based on paragraph 7(3)(a)(ia) of Schedule 15B to ICTA which was inserted by FA 1999. The condition applies only to acquisitions made on or after 9 March 1999 (see subsection (1)(b)). Subsection (7) confirms that shares not acquired for genuine commercial reasons are not treated as using part of the annual acquisition limit whether those shares were acquired before or after 8 March 1999. Prior to the FA 1999 amendments, such shares were not “relevant acquisitions”. Following the FA 1999 amendments, dividends paid on such shares cannot qualify for exemption and therefore the shares are disregarded for the purposes of determining whether the annual acquisition limit has been exceeded.
Section 710: Treatment of shares where annual acquisition limit exceeded
2715.This section is based on paragraph 8 of Schedule 15B to ICTA and provides an ordering rule to determine which shares are treated as within the annual acquisition limit (referred to as “exempt shares”) if that limit is exceeded in a tax year.
2716.Subsection (2) provides the basic rule, that shares are treated as exempt shares if immediately after their acquisition the annual limit is not exceeded.
2717.Subsection (4) deals with the situation where the limit is exceeded on a day in which shares of different descriptions are acquired. In that case the appropriate proportion of shares of each description are treated as exempt shares.
Section 711: Identification of shares after disposals
2718.This section is based on paragraph 8 of Schedule 15B to ICTA and sets out the share identification rules for disposals of shares in a VCT.
2719.The first rule (subsection (1)) provides the assumption that non-VCT shares are disposed of before VCT shares.
2720.The second rule (subsection (2)) applies if the annual acquisition limit is exceeded and some shares are disposed of. Clearly an investor will want to know whether the shares falling within the annual acquisition limit are disposed of or whether the other shares (referred to as “excess shares”) are disposed of. The section sets out the assumptions to apply. Shares acquired on an earlier day are treated as disposed of before shares acquired on a later day (see subsection (3)). If the shares are acquired on the same day, excess shares are treated as disposed of first (see subsection (4)).
2721.Subsection (5) is based on section 60 of TCGA, incorporating the rule relating to acquisitions and disposals by a person’s nominee, and acquisitions and disposals between a person and his nominee.
Section 712: Identification of shares after reorganisations etc.
2722.This section deals with the identification of shares following a reorganisation etc, for example, where there has been a bonus issue of shares or where there has been an issue of shares falling within section 135 or 136 TCGA. It is based on paragraph 8(3) and (4) of Schedule 15B to ICTA and sets out three rules.
2723.The first rule (subsection (2)), is that any “new shares” acquired as a result of the reorganisation etc. are treated as satisfying the conditions for exempt shares set out in section 709(4) and, if relevant, section 709 (6), if the “old shares” satisfied those conditions. Dividends paid in respect of the new shares therefore qualify for the income tax exemption under this Chapter.
2724.The condition in section 709(6) relates to shares acquired on or after 9 March 1999. If the “old shares” were acquired before 9 March 1999 the new shares do not need to satisfy the condition in section 709(6). The source legislation refers only to the new shares being treated as satisfying the annual acquisition condition. See Change 115 in Annex 1.
2725.The second rule (subsection (3)) is that if only a proportion of the “old shares” met the condition about the annual acquisition limit or the commercial reasons test then only the corresponding proportion of the “new shares” are treated as doing so. It follows that the remainder of the new shares are treated as not doing so. So dividends paid in respect of those shares would not qualify for the income tax exemption under this Chapter.
2726.The source legislation is silent as to whether “new shares” in excess of that corresponding proportion (“excess new shares”) get another chance to qualify as exempt shares if any of the current year’s annual acquisition limit remains available.
2727.For example, in the tax year in which the “new shares” are issued (say with a value of £150,000 of which £100,000 qualify under the corresponding proportion rule) further shares are acquired to a value of say £100,000. The issue is whether the £50,000 new shares which did not qualify under the corresponding proportion rule can be treated as falling within the annual acquisition limit because £100,000 of the current year’s annual acquisition limit remains available.
2728.Paragraph 8(4)(a) of Schedule 15B to ICTA ensures that the excess new shares are disregarded in determining whether acquisitions, made during the same tax year as the excess new shares are issued, come within the annual acquisition limit. The position of the excess new shares is dealt with solely under paragraph 8(4)(b) of Schedule 15B to ICTA. That sets out the extent the new shares are to be treated as acquired within the permitted maximum by reference to the status of the shares from which they are derived, that is, the proportionate basis. If they do not qualify under that provision, they do not qualify at all.
2729.It is not thought to be the intention of the legislation that excess new shares should have a second chance of being treated as falling within the permitted maximum. So subsection (3) provides explicitly that the remaining new shares are not treated as meeting the conditions to qualify for the income tax exemption. This is implied but not expressly stated in the source legislation.
2730.The third rule (subsection (4)) provides that the new shares are ignored in determining whether other shares acquired in the same tax year qualify for the income tax exemption.