The Enterprise Investment Scheme (EIS) was originally established in 1994 and since then has continued to expand so that today it is an extremely useful incentive in assisting companies to attract finance. At the end of last year the Government published official figures showing that over 2,500 companies had received EIS qualifying investments by the end of the 2012 tax year, with the amount of money raised being in excess of £1billion. Since these statistics were compiled the number of companies benefitting is likely to have increased.
The relief is such a good aid to attracting investment because investors are able to claim a number of tax reliefs, outlined below.
The relief is intended to assist companies in attracting outside investment, so there are rules in place which mean that investors must not be ‘connected’ with the company. This rule mainly excludes someone who is or has been an employee or director, or who controls more than 30% of the company.
So how can you use the EIS incentive to attract external finance into your company?
Firstly, you should check whether your company satisfies the qualifying criteria relating to trade, size, and the funds to be raised. If you think this is the case, then it is advisable to put the facts to HMRC under their ‘advance assurance scheme’ which allows a company to submit its plans before the shares are issued and seek advice on whether the proposed share issue is likely to qualify for EIS relief.
Once funds have been raised and the investment approved by HMRC, tax certificates can be issued to the investors to enable them to claim tax relief on their investment. The company must continue to carefully follow the eligibility criteria to ensure that the tax relief continues to be available for the investors throughout a qualifying period of 3 years following their investment. It is very easy to overlook this continuing requirement once the funds have been raised, but it is important to be aware of their existence and the ongoing role the company plays in ensuring any tax reliefs given are not withdrawn.
What qualifying criteria need to be met by companies seeking EIS approval?
Although there are many factors to be considered, below is an outline of the basic criteria which need to be met:
- Investment must be made by way of a subscription for new ordinary shares and must be wholly in cash and fully paid up at the time of issue. The shares must not be redeemable for at least three years and there must not be a pre-arranged exit;
- The shares must be issued to raise money for a qualifying business activity and all the money raised must be used by the company for a qualifying business activity within two years of the date of issue of the shares, or commencement of the trade if later;
- The company should be unquoted, but AIM and PLUS Quoted companies do qualify. It should be independent and not under the control of another company. If it controls any other companies, they must also be qualifying companies;
- The company should have gross assets of less than £15m before the EIS share issue and £16m afterwards;
- The company should employ fewer than 250 staff;
- It can raise no more than £5m per year from a combination of the EIS, Venture Capital Trusts and for start ups, SEIS (Seed Enterprise Investment Scheme);
- It should be a trading company and active in a qualifying trade – certain types of trade are excluded as outlined below;
- There is no requirement that the company is resident in the UK, but it must have a ‘permanent establishment’ in the UK.
The Seed Enterprise Investment Scheme (SEIS) runs alongside the EIS. It is a similar scheme which is aimed at early stage enterprises; the qualifying criteria are similar to EIS, although the tax reliefs are more generous whilst the amount of finance that can be raised under SEIS is significantly lower. The maximum amount of all SEIS investment together with any other state aid received by the company in a three year period must not exceed £150,000.
If however a start up business needs to secure a larger amount of funding than £150,000, it is possible to combine both SEIS and EIS, but any application for EIS cannot be made until 70% of the original funds obtained through SEIS have been utilised.
Which trades are excluded from EIS and SEIS?
Companies whose trades comprise more than 20% of the following activities will not ordinarily qualify for EIS or SEIS:
- Companies dealing in land, commodities or futures, shares, securities or other financial instruments;
- Companies dealing in goods that do not fall into the categories of either wholesale or retail distribution;
- Banking, insurance, loans, debt-factoring, hire-purchase financing or other financial activities;
- Leasing (including letting ships on charter or other assets on hire), or receiving royalties or licence fees;
- Provision of legal or accountancy services;
- Farming and market gardening, woodlands and timber production;
- Property development, although some construction businesses would qualify;
- Operating and managing hotels and nursing homes;
- Coal production
- Steel production
- Shipbuilding
- Providing services to a connected person conducting one of the above trades
- Receipt of Feed-in-Tariffs, unless from hydro power or anaerobic digestion.
How do investors in EIS or SEIS companies benefit from tax relief?
Once the company has secured the necessary HMRC assurance that the proposed funding will be eligible for EIS or SEIS, and once the necessary certificates have been issued, the investors are able to claim various tax reliefs. These are as follows:
Income tax relief
Individuals investing through EIS can benefit from 30% income tax relief subject to set criteria also being met. The maximum amount an individual can invest is £1m in a tax year although married couples and civil partners are entitled to separate allowances. The relief available for SEIS investment is 50%.
Capital gains tax exemption
No capital gains tax is payable on the disposal of EIS shares after three qualifying years of ownership; it is possible to retain EIS shares for a longer period to benefit from an extended CGT free gain period.
Loss relief
If the EIS shares are later disposed of at a loss, that loss (less any income tax relief given) can be offset against income of the year in which they are disposed of.
Capital gains tax deferral
Capital gains arising on the disposal of other assets can be deferred where the gain is invested in shares in an EIS qualifying company. The EIS investment must be made within one year before or three years after the gain arose. This is a deferral relief only; the gain originally arising will become chargeable when the EIS investment is disposed of or becomes a non qualifying investment. For SEIS investments, 50% of the original gain can escape the charge to tax entirely.
Inheritance tax relief
EIS shares typically qualify for 100% business property relief (BPR) after two years of ownership.
For more information on how to obtain HMRC pre assurance that a proposed investment will qualify for EIS relief, or if you an investor seeking advice on the tax implications of making an investment into an EIS company, please contact Lesley Stalker by emailing las@rjp.co.uk.