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LAM03640 | Calculation of ‘I’ Income and chargeable gains: Chargeable gains from venture capital limited partnerships: Scope and conditions of TCGA92/SCH7AD

From HM Revenue & Customs · Life Assurance Manual

Scope

The Schedule applies to insurance companies holding assets as a limited partner in a venture capital investment partnership (VCIP) SCH7AD/PARA2. ‘Limited partner’ is widely defined in PARA10(1) and the requirements are likely to be met by life insurance companies in most cases:

  • for UK partnerships, the company is carrying on business as a limited partner in a partnership registered under the Limited Partnership Act of 1907

  • for foreign partnerships, the life company is carrying on business jointly with others, and, under the laws of the country or territory concerned, not entitled to take part in the management of the business and not liable beyond a certain limit for debts and obligations incurred for the purposes of the business

A company is not regarded as taking part in the management of the business purely because it is represented on a committee advising on investment decisions.

Limited partners in partnerships formed under the laws of the following countries or territories, which are common partnership locations, would be expected to qualify:

  • Ireland

  • Jersey

  • Guernsey

  • Isle of Man

  • Delaware (and any other US state or territory adopting the Uniform Limited Partnership Act)

The rules apply for periods of account beginning on or after 1 January 2002 including straddling periods. There was an option to elect TCGA92/SCH7AD/PARA11 to disapply these rules for straddling periods and for investments where the company made its first contribution of capital to the partnership before 17 April 2002 (Budget Day). Where an election has been made to opt out, the normal partnership disposal rules would apply.

These changes in 2002 may still be relevant where assets are still held currently and an election was made previously under these provisions. The elections must have been by notice to an officer of the Board not later than 2 years after the end of the life company’s first accounting period beginning on or after 1st January 2002 TCGA92/SCH7AD/PARA13.

Conditions to be a qualifying partnership

Paragraph 2 Schedule 7AD sets out the conditions to be met by the partnership to be a VCIP. These are:

  1. the sole or main purpose of the partnership is to invest in unquoted shares or securities as evidenced from the partnership agreement or the prospectus issued to prospective partners

  2. the partnership does not carry on a trade

  3. not less than 90% of the book value of the partnership’s investments at the end of the partnership accounting period is attributable to investments that are either - shares or securities that were unquoted at the time of their acquisition by the partnership, or - shares quoted at time of acquisition but which it was reasonable to believe would cease to be quoted within the next twelve months. This allows the partnership to invest in listed companies which are intended to be de-listed, so-called ‘public to private transactions’

Holdings of cash or quoted shares and securities by the partnership

In determining whether the third condition – TCGA92/SCH7AD/PARA2(4) – is met, holdings of cash (including held in deposit or similar accounts) are disregarded unless acquired wholly or partly for the purpose of realising a gain on its disposal. Holdings of quoted shares or securities are also disregarded if they were acquired in exchange for unquoted shares or securities. Quoted has the usual meaning i.e. listed on a recognised stock exchange.

‘Fund of funds’ investments by partnership

Venture capital partnerships, especially those in the USA, often invest in other venture capital partnerships rather than directly in the shares of target investments, a so called ‘fund of funds’ approach. TCGA92/SCH7AD/PARA9 treats investments by a VCIP by way of a capital contribution to another VCIP as an investment in unquoted shares and securities. This allows the conditions in PARA2 to be met in these circumstances.

PARA9(2) contains a power to set out in regulations the precise way that such investments are to be taken into account by Schedule 7AD. Although attempts were made to agree with the industry an approach for the regulations to take, it was found impossible to cater easily for cases, which are common, where there are more than two layers of partnerships. In cases where there are difficulties with applying Schedule 7AD to funds of funds HMRC is open to agreeing a reasonable approach to the calculation of gains, following the Schedule 7AD approach as far as possible.

In some cases, the first level partnership may be treated as an opaque vehicle for income purposes, for example treating the investments of the first level partnership as if they were loan relationships and simply following the accounts charging all profits as income. This may be particularly appropriate in the case of US partnerships, where the only information available to the insurance company is that in the US tax return K1. Any agreements of this sort should be referred to the insurance policy team.

Partnerships ceasing to qualify

The requirement for the qualifying conditions to be met is ongoing. If the partnership ceases to meet the conditions for any accounting period then the life company will revert to the normal rules from the start of the accounting period of the partnership following that in which the partnership ceased to qualify TCGA92/SCH7AD/PARA2(6). There are no special rules for transition back to the normal rules.

A partnership that ceases to meet those conditions cannot qualify again as a venture capital investment partnership TCGA92/SCH7AD/PARA2(7). This avoids potential practical difficulties in moving from one basis of calculation to another in line with the aim of simplification.