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The Enterprise Investment Scheme (EIS) has been around for many years and is designed to help small and medium sized businesses obtain finance by offering generous tax reliefs to investors, who can invest up to £1,000,000 each year under EIS.
The Issuing Company Requirements
The company must be an unquoted trading company which is not under the control of another company. The company can have subsidiaries provided these too satisfy the relevant requirements and any prescribed limits will then apply for the group as a whole and not just the issuing company.
The company’s gross assets must not exceed £15m immediately before the share issue and £16m after and there must be less than 250 full-time (or full time equivalent) employees. This is extended to 500 full-time employees for “knowledge intensive” companies.
The company must carry on a qualifying trading activity, which precludes (but is not limited to) activities such as banking, holding licenses, legal and financial services, property development and farming. The share issue must generally take place within 7 years of the first commercial sale made by the company (or 12 years for a knowledge intensive company), or the total of all investments made within a 30 day period must equate to at least 50% of the company’s average turnover taken over a period of 5 years.
The important point to note here is that the legislation stipulates that the trade starts with the first commercial transaction undertaken, whether that be by the issuing company or by another person. This would then include, say, a trade started by a partnership before incorporation, with the ‘clock’ therefore not simply starting at the date of the issuing company’s incorporation. This is a new stipulation introduced by the Finance No2 Act 2015 in order to restrict the level of EIS investments to younger enterprise companies and to prevent the UK falling foul of the EU State Aid restrictions.
It will be interesting to see whether these limitations will remain once the UK formally leaves the EU.
The Investor Requirements
The investor must subscribe for new ordinary shares with no preferential rights – a purchase of shares from another shareholder will not attract relief.
If the investor already holds shares in the company these must either be subscriber shares or, if shares were acquired later, then these too must have been EIS shares for which relief was claimed.
The investor or an “associate” of the investor cannot be ‘connected’ with the issuing company in the period beginning two years prior to the issue of the shares, and ending three years after the issue of the shares
For these purposes ‘connected’ is defined as:
Being an employee of the company, although there are special provisions which would allow a director of a company to be eligible for EIS relief. An unpaid director in the 2 years before the share issue and 3 years after may still be eligible for EIS relief, and this is to allow for ‘business angel’ scenarios where an investor may be appointed to the board in order to provide the company with guidance or a particular expertise.
Having a substantial interest in the company, i.e. holding or being entitled to hold more than 30% of the company’s share capital or voting rights.
When considering the above the associates of the investor must also be considered, which include parents, grandparents, children, partners, and their spouses.
The investor must then keep the shares for a minimum period of 3 years in order to retain the tax reliefs, as detailed below.
The Income Tax Reliefs
By subscribing for qualifying EIS shares (which are ordinary shares with no preferential rights) the investor will receive 30% income tax relief. By way of an example an investment of £100,000 will result in a reduction to the investor’s tax liability of £30,000 such that the net cost to the investor is actually £70,000. As the maximum that can be invested by an individual in any one year is £1,000,000 the maximum income tax relief is £300,000 per annum. This maximum investment amount increases to £2,000,000 where shares are subscribed for in knowledge intensive companies, and therefore a maximum relief of £600,000 is available.
If the shares are disposed of within the 3 year holding period any income tax relief given is clawed back. Investments made in one tax year are eligible for relief in that year or can be treated as made in the previous tax year.
Further income tax relief may be available if the shares are sold at a loss, see below.
The Capital Gains Tax Reliefs
Provided that the EIS shares are held for 3 years any capital gains realised on any eventual sale will be free of CGT.
EIS ‘Reinvestment Relief’ also enables capital gains realised on any assets to be deferred when the proceeds are used to reinvest in EIS qualifying shares, based on the lower amount of either the gain or the amount reinvested, though it should be noted that the reinvestment must take place within a specific window in order to qualify. For example if there are capital gains of say £80,000 in a tax year and an investment of £120,000 is made, the entire gain of £80,000 can be rolled over and does not become chargeable to CGT until such time as the EIS shares are sold.
For sales of assets after 3 December 2014 qualifying for Entrepreneurs Relief, the deferred gain coming back into charge will still be eligible for Entrepreneurs Relief.
It should also be noted that gains coming back into charge to Capital Gains Tax are subject to tax at the rate applicable in that year, not the year of the original investment. Gains can be deferred into EIS investments made up to 5 years after the gain is made, and so a gain made in 2019/20 could be deferred and come back into charge in a later tax year with a potentially different Capital Gains Tax rate.
In the unfortunate event that any loss arises on a disposal of the EIS shares this loss will be allowable for CGT purposes. The loss arising new of any income tax relief given and not clawed back, can be set against other capital gains made or against income.
How can we help?
If you would like more information or have a specific query, please contact us, as we shall be happy to advise further.
Please note: This piece only contains the basic principles of EIS relief and is in no means a detailed guide, its purpose being to provide a broad outline/introduction. Professional advice should be sought by any company wishing to raise funds or any individual wishing to make a tax efficient investment by way of any risk finance investment.
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