Up to 30 per cent income tax relief is available for individuals who subscribe for qualifying shares in companies who register and qualify for the Enterprise Investment Scheme (EIS), provided they hold those shares for a minimum of three years.
This relief is available for a minimum investment of £500 and a maximum investment of £1 million in any one tax year. For companies requiring funds for growth, the EIS is therefore a very useful vehicle for securing business finance from high net worth private investors. For such companies, it is possible to raise up to £10 million in any one tax year by this route.
However, entrepreneurs should note that each company application to raise funds through the EIS is carefully scrutinised by HMRC, which is evident from a recent case brought to the Tax Tribunal involving a company that invested in pubs. This highlights how important it is to carefully adhere to guidelines and properly interpret the rules, to ensure that tax relief already given to individual investors is not withdrawn.
To quote HMRC’s website, ‘It is important that investors are aware of the rules the company has to observe, not just at the time of the investment but for at least three years afterwards.
‘If it fails to meet those rules tax relief will not be given, or, if it has already been given, will be withdrawn.’
It goes on to state that ‘both investors and companies should note that no relief will be given (or if it has been given, it will be withdrawn) if any scheme has as its main purpose, or one of its main purposes, the avoidance of tax.’
In addition to the income tax relief outlined above, valuable capital gains tax reliefs are available to individuals investing in qualifying EIS companies; firstly the growth in the value of the EIS shares can be free of capital gains tax; secondly it is possible to re-invest capital gains made on the sale of other investments, within certain time limits, and defer the point at which the capital gains tax (CGT) becomes payable. Finally, if the EIS shares give rise to a capital loss, that loss can be offset against income.
There are a number of conditions which apply for the income and capital gains tax reliefs to be available and these are broadly outlined below. However one condition which can be overlooked, or in fact can become outside the company’s control, is that the money raised must be used for the purposes of the company’s trade (or research and development) within two years of the shares being issued, or within two years of the commencement of trade, whichever is the later.
Therefore it is important that companies do not raise money under the EIS unless they are reasonably confident of meeting this requirement.
The recent case mentioned above fell foul of this condition: an individual made an investment through the EIS in a pub company, because the pub’s owners wished to acquire an additional venue.
However before contracts had been exchanged, the vendor withdrew the pub from sale and the company involved simply left the funds raised from the EIS investor in a deposit account. Over two years later, after the company had made a trading loss, they decided to utilise the money raised to cover the losses and also to renovate and extend their existing premises.
The crux of the argument in this case rested on the company’s misinterpretation of HMRC’s requirement for any money invested through EIS to be ‘employed wholly for the purpose of the company’s trading activity within 2 years of the share issue’.
As far as HMRC is concerned, in order for the funds raised to have been ‘employed’ they must ‘actually be used in some way for the purposes of carrying on the qualifying activity within the relevant period’.
In this instance, the money had not been ‘employed’ in the company’s qualifying activities until after the company suffered losses two years later, hence the disqualification by HMRC which was upheld by the Tax Tribunal.
To qualify for the Enterprise Investment Scheme (EIS) a company needs to be registered and fulfil the following criteria throughout the three-year qualifying period during which the shares are held, otherwise the tax reliefs for individual investors will be withdrawn:
- Be an unquoted company;
- Issue only fully-paid issued shares;
- Be a trading company carrying on a qualifying trade and have a permanent establishment in the UK;
- Exist for genuine commercial purposes, and not be part of a scheme for the avoidance of tax;
- Not be a 51% subsidiary of another company, or otherwise be under the control of another company;
- Have assets of £15million or less before the investment;
- Employ less than 250 employees.
EIS investments are attractive for higher rate tax payers who are able to accommodate the inherent risks of investing in high risk companies. In return, they can obtain the following benefits:
- Income tax relief at 30 per cent on the amount they subscribe for qualifying shares in an EIS registered company, up to a maximum investment of £1m p.a.
- Capital gains tax –free growth
- Roll-over of other gains into the acquisition cost
- If the shares make a loss, the opportunity to offset that loss against income.