If you’re thinking about making an investment, you may have come across the terms Enterprise Investment Scheme and Seed Enterprise Investment Scheme. Known more concisely as EIS and SEIS, they’re not new – EIS was introduced in 1994, SEIS in 2012 – but were given fresh attention in last year’s Autumn Budget (as covered by us here).
As a taxpayer, you may be attracted by the valuable tax breaks which EIS and SEIS can provide. As tax specialists, we have experience of the rules governing these schemes, which can be quirkier and more counterintuitive than many people initially realise.
By familiarising yourself with the pitfalls that are present in the legislation, and taking care to avoid them, you may successfully claim and retain the tax reliefs available to potential EIS and SEIS investors.
What reliefs are there?
The reliefs cover income tax, capital gains tax (CGT) and disposal of shares.
- Income tax relief under EIS: upfront tax relief of 30% for up to £2 million per tax year. This is provided that the shares are retained for at least three years.
- Income tax relief under SEIS: upfront tax relief of 50% for up to £100,000 per tax year.
- CGT relief under EIS: parallel to the EIS income tax relief is a CGT deferral regime which is subject to broadly similar conditions. Under this deferral regime, a gain (not limited to the £2 million mentioned above) may be “rolled over” into an issue of EIS shares.
- CGT relief under SEIS: 50% exemption for capital gains reinvested through SEIS (subject to the £100,000 investment limit) leaving only 50% of the gain taxable.
- Tax free disposal of SEIS shares under EIS and SEIS: no CGT is payable on the disposal of shares that are held for more than three years. If a loss arises on the disposal of the shares, the balance of the loss (i.e. after deducting the initial tax relief) can either be claimed as a capital loss or alternatively be offset against general income for the year.
From an awareness of the reliefs, it’s worth building an understanding of the EIS/SEIS rules and their three Rs: requirements, restrictions and relaxations.
‘Connection’ with the company
EIS/SEIS income tax relief is not available to an investor who, together with an ‘associate’ – who may be their spouse, civil partner, (grand)parent or (grand)child – holds a 30% plus interest in the company. An ‘associate’ includes not only a relative but also a business partner of the investor.
In our experience, this is where it can all go horribly wrong. It is more common than you might think for business partners to invest together and find their EIS relief lost because their interest in the company exceeds the 30% level. This stems from the requirement that the investor is ineligible if ‘connected’ with the issuing company at any time during the period
- beginning two years before the issue of shares; and
- ending three years following the share issue.
In particular, you may not invest under the schemes if you are an employee of the company and, in the case of EIS (but not SEIS), a director of the company.
There is a relaxation to this general rule if, at the time of the EIS subscriptions, you
- were a director of the company when the company had not carried on a trade; and
- are neither paid nor have an entitlement to be paid.
A further relaxation applies for a director if the ‘business angel’ conditions can be met. As an investor, this allows your EIS investment to qualify for relief even if you are a paid director, where the issue of the EIS shares takes place in the three-year period following an earlier share investment by you that itself qualified for EIS or SEIS relief.
The ‘independence’ requirement
A company must satisfy this requirement for its shares to be eligible for EIS or SEIS. This broadly means that:
- It is not a 51% subsidiary of another company;
- It is not under the control of another company though not a 51% subsidiary of that company; and
- Although not a 51% subsidiary, it is under the control of another company and other persons connected with that company.
Furthermore, no ‘arrangements’ can be in existence by virtue of which the company could become such a ‘subsidiary’ or fall under such ‘control’. For this purpose, control is obtained where a person/company secures that the affairs of the company are conducted in accordance with its wishes by virtue of the possession of shares, voting control or rights set out in the company’s Articles of Association or other document.
If the independence requirement is compromised within three years of the EIS share issue, the investor’s shares will lose their EIS/SEIS tax favoured status and result in a clawback of the tax relief obtained.
The ‘maximum age’ requirement
This requirement was introduced to ensure that tax relief is targeted on investments in:
- earlier-stage companies;
- companies that need several rounds of tax-advantaged funding before the market will invest in them; and
- in certain specific circumstances, companies whose activities are changing so substantially as to constitute a new business activity.
Companies must raise their first EIS investment within seven years of making their first commercial sale or 10 years if the company is a ‘knowledge-intensive’ company, though the ‘age limit’ may not apply in circumstances where the company satisfies an annual turnover condition.
The opportunity of future EIS investment by a company whose shares would normally qualify for EIS funding may be lost if the company acquires another company or a business which made its first commercial sale more than seven years ago. Similarly, a clawback of EIS relief could arise if EIS monies raised previously are used to support the business of that newly acquired company or trade.
All of this shows that for a potential EIS or SEIS investor, there are many complex and obscure conditions which need to be fulfilled before relief may be claimed and retained. Usually, but not always, all of these conditions will be considered and reviewed carefully and assiduously before the scheme is put into place, but the monitoring must continue in the three years following the investment to avoid a loss of the relief.
If you would like further guidance on EIS and SEIS rules for investors and companies, our tax specialists can help. Please get in touch with your usual BKL contact or use our enquiry form.
