Paul Webb, tax partner at Robert James Partnership, explains how entrepreneurs can benefit from an improved Enterprise Investment Scheme.

For business owners, one of the most useful policies introduced in the 2011 Budget was the enhancement to the Enterprise Investment Scheme (EIS).

It has also been welcomed by higher rate taxpayers looking for tax efficient ways to shelter their income from the current 50 per cent tax rate. In fact, it has been estimated that EIS could be worth £450 million in tax relief to investors in the next five years.

With the increase in income tax relief from 20 per cent to 30 per cent meaning that this is more valuable relief, access to the EIS scheme has also been widened.

Qualifying for EIS

If you have a small business and the opportunity exists to attract investment through EIS it is necessary to register for the scheme. You also need to meet certain criteria.

The company must be unquoted and must not be under the control of another company or of a company and persons connected with that company. It must also be a qualifying trading business or be the parent company of a qualifying trading group. Certain types of company, for instance those dealing in property, are not eligible.

A minimum of 50 per cent of the qualifying trade must be carried out in the UK and the business must be permanently established in the UK, gross assets must not exceed £7 million before the EIS share issue (this limit increases to £15 million from April 2012).

And finally, from April 2012, a maximum of £10 million in funding can be raised in any 12-month period under the EIS and the maximum employee limit will increase from 50 to 250 employees.

Rules for investors

Investors claiming EIS tax relief must satisfy a number of conditions. Shares must be ordinary with no preferred rights and held for at least three years.

The shareholding must also not exceed 30 per cent of the issuing company either alone or when aggregated with associates. This is measured either by share capital, share capital and loan capital combined or voting rights.

Additionally, the investor must not be employed by the issuing company, subject to an exception for certain paid directors or if certain conditions for MBO apply.

EIS relief for MBOs

In addition to an expansion of the qualifying criteria, tax relief may now be available in management buy-out (MBOs) situations.

Historically relief was denied in MBOs as the investing individuals (usually managers or directors of the old company) were deemed to be connected with the new company making the investment.

However, following a recent decision by the First Tier Tribunal, it may now be possible to obtain EIS relief on future MBOs as well as on certain historical transactions.  

In the past, EIS has been very successful at attracting investment into smaller, entrepreneurial businesses.

Now, at a time when traditional sources of funding remain difficult to access, it is highly sensible that the government has chosen to make EIS more tax efficient for investors and it’s at just the right time to encourage the economic recovery.

See also: Top 20 EIS funds and investors you should know about