BES offers shelter in tax storm

A proposed cut in tax relief on pensions would add a further incentive for BES investors

AS THE Government continues to clamp down on tax shelters and with the outlook for pensions uncertain following the recent Commission on Taxation report, the Business Expansion Scheme (BES) is one of the view viable options left for investors looking for some tax relief.

Established to encourage investment in small and medium-sized private businesses operating in certain sectors, in 2007 the scheme was extended until 2013 and was significantly strengthened. The qualifying amount for tax relief was increased from €31,750 to €150,000 for investors and the amount that could be raised by qualifying companies was raised to €2 million, although it is subject to a limit of €1.5 million in any one-year period.

These improvements, combined with the ongoing credit crunch, have led to continuing demand for the scheme. Last year, 497 companies applied to the Revenue Commissioners for BES qualification and, so far this year, there have been 311 applications.

“The number of inquiries from companies seeking to raise funding has increased significantly in recent years on the back of both the increased funding limits of €2 million permitted under BES and the difficulties facing businesses in raising funds elsewhere,” says Chris Ball, a director with RBK Corporate Finance.

While not all qualifying companies will go through with raising finance – according to the Revenue, 98 companies have been pre-approved for BES relief so far this year – a broad range of BES opportunities exists for investors willing to take on the risk of investing in small and medium-sized companies.

However, while there may be a steady flow of companies lining up to use the scheme to raise finance, investors remain cautious. In 2008, some €135.7 million was invested in BES companies/funds, with 2,462 individuals making 3,200 investments in the scheme, up from €39.6 million in 1,910 investments in 2007. Since then, however, investors have become more risk-averse.

John O’Grady, a director with Horwath Bastow Charleton, says the investor market has shifted over the past while, with investors slow to take on risk.

Nevertheless, Ball notes that there appears to be an increase in the number of inquiries from investors seeking BES investment opportunities, indicating that appetite is beginning to come back to the market.

For investors who are willing to take on the risk in the current environment, O’Grady points out that the quality of company looking to raise funds through the BES has improved substantially.

“Now, companies which have been profitable for years and years are looking for funding, companies which might not normally have come to BES but have come because the banks won’t lend to them,” he says.

The major attraction of investing in BES qualifying companies is the tax relief on offer, which is available at the marginal rate of tax.

For example, say you invest €10,000 in a company promising a modest return of 20 per cent over the five-year period. At the end of this period, the company meets it obligations and returns €12,000 to you, thereby ensuring your investment has grown by 20 per cent.

The real return is much higher, however, given the tax relief on offer as the net cost to you of the investment of €10,000 will have been just €5,900. So the actual return you have achieved is closer to 100 per cent.

Investors can get tax relief on investments ranging from €250 to €150,000 in any one year, while it is also possible to carry the balance forward.

Generally, BES companies undertake to buy your investment back at market value at the end of the five-year period required by the scheme, subject to a cap.

“Very few will promise you full growth in the company,” notes O’Grady. So, for example, a company could promise to give you 40 per cent of the growth in the company at the end of the defined period.

While it can be difficult to ascertain the market value of the company at the end of the five-year period, BES companies – if they are still around – will usually deliver on what they have committed.

Among the more notable BES successes have been coffee company Java Republic and accounting software firm Big Red Book; this year a wide range of companies, including biotech, tourism and services companies, are looking to raise funds through the scheme. How THOUGH can you pick the right investment?

Firstly, tax relief shouldn’t be the primary reason for your investment.

“You need to make sure it suits your own personal risk profile. Tax relief won’t comfort you if you make a loss or if the company goes belly up,” says Yann Harrison, a qualified financial adviser with Russell Brennan Keane, adding that investors should look on the tax relief as a bonus, not as a reason for investing.

“It should be evaluated under the normal criteria – does it offer value for money? Is there good investment potential?”

For O’Grady, the quality of management is key. “Look first and foremost at the people behind the company. What’s their track record? What success have they had? Do they have credibility?”

He also advises that you should look at the company’s historic trade and its last three years of profit-and-loss accounts. “Are you going into a company that’s already loss-making or is it already profitable and hoping to use the investment to increase capacity and expand?”

If a company has no proven profitability, it will increase the risk of your investment, he adds

Given that you are investing in a small enterprise, often a start-up with no record of profitability, in a very difficult economic environment, it is clear that the risks of investing in a single BES company can be high.

As such, BES investments are not for everyone. “By definition it’s a risk-based investment,” says O’Grady and, for some, the BES has been tarnished because of company failures, such as the collapse of furniture retailer House of Denmark. If the company fails, it brings your investment with it and, as O’Grady points out, BES companies tend to be “either very successful or they’ll fail”.

However, with the level of tax relief on offer, risks are capped on the downside. For example, if you invest €10,000 in a company that goes to the wall, you can only lose 59 per cent, or €5,900, of your investment, given that you have gotten a rebate on your tax bill of the other €4,100.

If you are still keen to invest, but feel that the risks of investing in one company are too high, a less risky alternative is to spread your risk by investing in a fund of BES companies.

“If €10,000 goes into a BES fund, it is split up and invested in anything from six to 100 companies. If one collapses, it doesn’t bring the whole fund with them,” says O’Grady.

There are currently about half-a-dozen BES funds on the market, each following different investment objectives. For example, Simple.ie’s Green BES Fund aims to invest in companies that, “at the very least, engage in business with an attention on energy conservation, waste reduction or social responsibility”.

It also invests in renewable energy or waste management or technologies connected with these sectors.

Others, such as Quintas Wealth Management’s BES Fund, invest in a broader spectrum of BES companies.

BES funds generally charge a commission fee of about 3-4 per cent and, if you go down this route, you may also have to wait some time to get your tax relief.

With a company, once the Revenue signs off on your investment, you will get your tax relief, but with a fund you will have to wait until all the money is invested.

For example, if you invest money now in a BES fund, it may not make its first allocation until next March and may continue to invest throughout 2010, which means that you can’t get your tax back until the end of the year.

Looking ahead, Harrison notes that the BES scheme may become more popular if the recent Commission on Taxation’s recommendations on pensions are introduced.

Given that the commission proposed a significant reduction in the level of relief available to those paying tax at the higher rate, Harrison suggests that investors will start looking to maximise their tax relief by looking at alternatives to pensions, such as BES schemes and film relief.

In addition to the higher tax relief on offer – 41 per cent compared to the report’s recommended 38 per cent for pensions – another advantage of such schemes is that you can see your returns in one or five years, rather than over a much longer period with a pension.

As such, Harrison says, if the commission’s proposal is introduced, “it wouldn’t augur well for pensions”.

YOU CAN...

...invest up to €150,000 per annum each year up to 2013 in a scheme or schemes approved by the Revenue. Normally the minimum investment required to qualify for relief under the BES scheme is €250.

...as a company owner secure invest of no more than €2 million, with no more than €1.5 million of that raised in any one tax year. However, the limit applies not just to one company but to a group of companies owned by the same person/people.

...receive tax relief on your investment at your marginal, or upper rate of tax

...invest only if you are resident in the State for tax purposes in the year for which you will claim relief under the BES scheme.

...not personally be connected with the company in which you are investing.

...invest either directly in one company or in a series of companies through a Businmess Expansion Scheme fund

...invest only in firms engaged in certain manufacturing, service, tourism, research development, plant cultivation activities, construction/leasing of advance factories and certain music recording activities.

...invest only in companies that are not quoted on a stock exchange. However, companies listed on the Irish Enterprise Exchange (IEX) or whose shares trade unofficially or “over-the-counter” do qualify

...invest only in shares that do not carry preferential rights

...only in a company which is trading at the time of the BES scheme or which will start to trade within two years of the share issue, unless it is a qualifying company involved in RD in which case it must trade within three years of the share issue.

...invest in a BES company for a fixed period of five years under the BES scheme.

...invest only on your own behalf and not on behalf of other people.

Choosing BES investments

If you're looking for a BES investment, you can either invest directly in a company, or make an allocation to a BES fund. Some options are listed below.

QUALIFYING COMPANIES

Isengua Limited

A start-up that claims to be one of Ireland's most innovative web-based English language training groups. The company is raising €900,000 to develop and market a platform for delivery of English language (and other subjects) online.

Contact: Sean Featherstone (01-8559425)

Isaacs Hostel and Jacobs Inn

Two Dublin hostels, in business for more than 20 years. The owners say they have been consistently profitable. Currently raising €1.5 million for refurbishment programme including new facilities with the objective of maintaining status as, in their words, "Dublin's top hostels".

Contact: Ann Breslin (01-8134700)

City Canal Cruises

A Dublin water-based tourist service. A start-up business, it is raising €100,000 to complete the purchase of a €600,000 barge manufactured in the Netherlands for operation on the Grand Canal. The balance was raised successfully last year.

Contact: Sam Field Corbett (086-8304444)

MB Quinn Sons

This company manufactures wood shavings for animal bedding. It needs to invest in order to increase capacity as it sells more than it can produce. It is also involved in the production of briquettes using the shavings.

Contact: Micheal Quinn (086-8196016)

Protectas Health

Protectas Health Ltd is a life science business established in 2006. It operates the world's first commercially dedicated storage facility for equine umbilical cord blood, extracted from thoroughbred foals at birth.

The blood sample is processed to deliver a high concentrate of stem cells. These are cryogenically frozen and stored on site for treatment of injury throughout the horse's lifetime.

Contact: David Crimmins, Terry Sullivan, Dermot Dougan and Margaret Goggin

Alimentary Health Ltd

A speciality biotech company, developing probiotic strains for the management of inflammatory and infectious disease, primarily based around digestive disorders.

Procter Gamble has launched two products based on technology licensed from Alimentary Health. The company was established in 1999 by its chief executive Dr Barry Kiely and a number of academics from University College Cork in the microbiology, medicine and food science departments.

BES FUNDS

Pinnacle BES Fund

The fund is managed by Pinnacle Capital Partners, Limerick, the directors of which are all partners of accountancy firm Horwath Bastow Charleton.

The fund seeks to invest in companies with a strong profile of existing management and shareholders and with a history of strong performance and/or benchmark company.

The minimum investment is €5,000 and subscriptions thereafter must be made in multiples of €1,000 up to a maximum of €150,000. The fund runs for a five-year term.

Simple.ie Green BES Fund

The fund is managed by BVP Investments and it invests in "green" companies, which also qualify under the business expansion scheme legislation. To date, the fund has invested in some of Ireland's most innovative, high-potential companies such as Wavebob, Celtic Bioenergy, EFT Controls, Biomass Heating Solutions and Skypaq.

The closing date for this year's fundraising is December 31st and investors can invest any amount from €5,000 up to €150,000. The fund targets investment returns of 15 per cent per annum over the five-year period of investment.

Quintas Wealth Management BES Fund

Managed by Cork-based Quintas Wealth Management, the fund hopes to raise €10 million before the end of the year.

The firm's investment criteria include investing in companies in which the management team and shareholders have a strong financial profile and good personal standing, and there is a recognised market for the company's product(s) and a well-defined market strategy. No individual investment will exceed 40 per cent of the value of the fund.