BES and seed capital relief code must be simplified

Budget 2007:Minister has an opportunity to give these schemes real vitality in the Finance Act, writes David Kennedy

The changes to the Business Expansion Scheme (BES) and Seed Capital Scheme announced by the Minister for Finance on Wednesday represent a significant boost to the SME sector.

The changes have the potential to serve as a real stimulus for indigenous startups and small business development. But the supporting legislation is less than perfect and needs to be substantially simplified and modernised to realise that potential.

The changes see the individual annual investment limits increase considerably to € 150,000 (BES) and € 100,000 (Seed Capital Scheme) as well as the corporate cap on BES fundraising doubling to € 2 million.

The BES was introduced in 1984 primarily to support the establishment of startup manufacturing businesses. From the outset the legislation was unnecessarily complex and restrictive. Since 1984 incremental legislative amendments have served to add to the range of industry sectors qualifying for BES funding but have also added considerably to the complexity and restrictiveness of the relief.

Consequently, raising and maintaining BES funding can often be unnecessarily expensive. Having bred new life into these schemes on Wednesday, the Minister now has an opportunity to give them real vitality in the 2007 Finance Act.

Ireland's economic cycle has also turned full circle since the mid 1980s.

A vibrant entrepreneurial spirit is now engendered in our graduates while the weight of money in the economy to potentially support this entrepreneurial spirit has never been greater. A simplified BES and seed capital regime can serve to direct some of this money towards supporting our entrepreneurial spirit. The need for simplification of the BES and seed capital relief code is overwhelming. In simple terms the code provides that "investments by individuals of up to € 150,000 per year in small or medium-size enterprises qualify for income tax relief". However, the legislation giving effect to this simple proposition takes up 57 pages with 21 legislative sections and a further 159 sub-sections largely comprising unnecessarily restrictive conditions.

This contrasts with the five pages, one section and 14 sub-sections of legislation governing the corresponding corporate tax incentive for investments of up to € 12.7 million in renewable energy projects.

It serves to considerably increase the compliance costs for SMEs. . A considered simplification of the BES code, without taking from its focus on the provision of real risk capital in the SME sector, is recommended.

The BES regime currently extends to traditional manufacturing activities and to certain computer services including software development services, data processing services and call centres. It also extends to a range of other sectors including film production, record production, aircraft maintenance, certain horticultural activities and, notably, to certain research and development activities. However, it doesn't serve to encourage investment by individuals in certain important sectors such as in renewable energy projects and waste recycling activities which are priority sectors of our economy today.

Specific tax incentives exist to encourage corporate investment in renewable energy projects. While it seems likely that the BES regime could, in theory, apply to attract individual investment in projects in the solar, wind, hydro and bio mass power sectors, the scale of such projects and the very restrictive nature of the BES legislation would likely serve to curb the attractiveness of BES funding for startups in the renewable energy sector.

A simplification of the BES legislation and the application of an increased project cap for approved renewable energy projects could act as a spur to encourage investment by individuals in the renewables sector.

Extending the application of the BES in the horticultural sector to encompass cultivation of seeds and plants for bio fuel production, and to encompass waste recycling activities, would also seem to have merit.

The Seed Capital Scheme predominantly serves to encourage employed persons to leave their employment and start up their own business. The increased limits introduced by Mr Cowen on Wednesday can serve as a real impetus in this context.

However, given that this scheme is restricted to bona fide entrepreneurs, there is no reason why the scope of the seed capital regime could not be extended beyond the traditional BES areas to include services sectors such as, for example, the childcare and healthcare sectors.

Mr Cowen's proposal to invite public consultation in relation to vehicle registration tax and VAT on property is welcome. In the case of the BES and the Seed Capital Scheme, a similar approach to consultation in advance of Finance Bill 2007 can usefully serve to ensure that the changes announced on Wednesday can reap their full potential.

David Kennedy is a tax partner in KPMG