Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)
by Tom Daltry
10th Apr 2013
Tax expert Tom Daltry reviews the enterprise investment and seed enterprise investment schemes, taking into account changes announced in the March 2013 Budget, and comments on which scheme might be attractive to angel investors.
Tax Benefits of EIS
Eligible individuals (e.g. business angels who satisfy relevant conditions) investing in new shares issued by a qualifying company can secure the following tax benefits:
- capital gains tax (CGT) deferral relief– tax realised on the disposal of another asset can be deferred by reinvesting the gain realised on that disposal in EIS eligible shares;
- income tax relief– income tax relief can be secured in respect of the amount invested in EIS eligible shares, subject to an annual limit on the amount invested of £1,000,000. Relief is given at the rate of 30%. In real terms, this equates to a maximum tax saving of £300,000; and
- CGT exemption– an exemption from CGT in respect of any capital gain realised on the disposal of the EIS eligible shares.
Further information on the above reliefs and a summary of the main conditions to be satisfied in order to secure the reliefs is provided below. Reference is also made to further income tax relief which can often be secured in cases where the investor suffers a loss.
CGT Deferral Relief
- Deferral of tax arising on the disposal of any other asset is available if the EIS investment is made in the period beginning one year before and ending three years after the date the gain arose.
- There is no limit on the amount of the gain to be reinvested in the EIS shares which can attract the deferral relief. To the extent that the gain is reinvested by way of a subscription for EIS shares, the tax deferral can be secured.
- The conditions to be satisfied (relating to the company in which the reinvestment is made, the shares acquired and the application of the money reinvested) are set out in Appendix 1 to this Briefing. In addition, the investor must be UK tax resident;
- The tax deferred by making the reinvestment becomes payable in prescribed circumstances, which include the following:
- the investor disposes of the EIS shares (the subject of the reinvestment);
- the investor becomes non-UK resident within three years of the investment; and
- the EIS shares cease to be eligible shares (see Appendix 1) during the period of three years after their issue.
- Deferment is not always advantageous. There can be circumstances in which the tax payable following the period of deferment will be greater than that which would have been payable on the original disposal, if no deferment had been sought.
Income Tax Relief
- 30% income tax relief is available on amounts invested in EIS eligible shares, subject to a maximum annual amount of £1m (£500,000 for shares issued before 6 April 2012).
- An election can be made to treat the shares as having been issued in the previous tax year, so that income tax relief can be claimed in that previous year (e.g. where the £500,000/£1m limitation was not utilised in the previous year).
- It is necessary to obtain an EIS certificate from the investee company and HMRC must authorise the company to issue this.
- The conditions to be satisfied (relating to the company in which the investment is made, the shares acquired and the application of the money reinvested) are set out in Appendix 1 to this Briefing. It is possible to obtain a provisional clearance from HMRC, in advance of an investment being made, that the relevant conditions will be satisfied.
- In addition, the individual making the investment must not be “connected” with the company for a period from two years before the issue of the shares (or the date of incorporation, if later) and ending three years after the issue of the shares, or after the trade commences, if later. The individual will be treated as connected with the company, and so not eligible for income tax relief, if he/she:
- has, or is entitled to acquire, more than 30% of the issued ordinary share capital or of the voting power of the EIS company or any of its subsidiaries; or
- is employed by, or is a director of, the company or any of its subsidiaries (or a partner of the company or any of its subsidiaries); or
- is a partner of the company or a subsidiary.
- The individual can qualify for relief, even though he/she is “connected” with the company solely by reason of being a director, if, when the shares are issued, he has never before been connected with the company or involved in carrying on its trade. In such circumstances it is also possible for the director to receive reasonable remuneration for his duties as a director and the individual will not be disqualified if he also becomes an employee. This relaxation of the connected persons rule is aimed at business angels who are to make their expertise available to the company.
- Relief will be withdrawn if the shares are disposed of within the period ending three years after the issue of the shares, or after the trade commences, if later. Relief will also be withdrawn to the extent that the investor receives value from the company in the period starting twelve months before the date of acquisition and ending three years after that date, or after the trade commences, if later.
- An exemption from CGT on a disposal of the EIS shares made more than three years after their acquisition, or after the trade commences, if later.
- This exemption is only available for shares which have qualified for income tax relief.
- If income tax relief is not given on the full amount invested (e.g. because the amount exceeds the permitted maximum) the CGT exemption will be restricted to a proportion of the gain.
The Investor's Net Exposure - Relief for Losses
If an investor suffers a loss on his investment in shares greater than the amount on which income tax relief was obtained, further income tax relief can often be obtained at the individual’s marginal rate. This means that the effective loss suffered by an individual who pays income tax at the top rate of 45% (i.e. assuming loss arises after 5 April 2013) may be limited to 38.50p in the pound, as illustrated below.
Investment of £10,000 in shares in XYZ Co. – EIS income tax relief for the investor of £ 3,000.
Three years later XYZ Co. goes into insolvent liquidation - no return to shareholders.
Investor can claim relief against his income for a loss of £10,000 less the £3,000 EIS income tax relief previously secured, i.e. loss relief on £7,000, resulting in a tax benefit of £3,150 for a taxpayer who can utilise the full amount of the relief at 45%.
So, total income tax relief secured is EIS relief of £3,000 + loss relief of £3,150 = £6,150.
Total loss on an investment of £10,000 after tax relief of £6,150 = £3,850.
The extent to which this additional relief will be available (if at all) will be dependent on the facts of each case.
Seed Enterprise Investment Scheme
This new type of EIS relief is aimed at start-up companies. It is available for shares issued between 6 April 2012 and 5 April 2017, where all relevant conditions are satisfied.
Tax benefits of SEIS
Eligible individuals can secure the following tax benefits under SEIS in respect of cash subscriptions for new shares:
- 50% income tax relief on the amount invested, subject to an annual limit of £100,000 for each investor.
- Exemption from CGT on disposals of shares which attracted income tax relief, provided that relief has not been withdrawn.
- A CGT holiday for gains realised in 2013/14 (in respect of any type of asset) when the gain is reinvested in that same year in shares attracting SEIS relief. The CGT exemption is in respect of 50% of the SEIS investment (and therefore limited to £50,000 of gains).
Requirements for Securing SEIS
Many of the conditions for EIS also apply to SEIS. Appendix 2 summarises the main conditions to be satisfied. Listed below are some of the key features which distinguish SEIS from EIS:
- The company must be a seed stage company; i.e.:
- the shares must be issued within two years of commencement of the business;
- the company's gross assets must not exceed £200,000 when the shares are to be issued and the company must have fewer than 25 employees;
- the maximum the company can raise under SEIS is £150,000 and it must not previously have had any EIS or VCT investments; and
- the company's main purpose must be to carry on a new qualifying trade and there must be a genuine new venture.
- The investor cannot be an employee unless he/she is also a director. Unlike EIS, any paid director can secure SEIS, subject to the same 30% restriction on the investor’s shareholding as applies to EIS.
- Other general requirements for SEIS (where it differs from EIS) are as follows:
- The money raised for qualifying business activities must be spent on those activities within three years.
- Qualifying business activities are defined as carrying on or preparing to carry on a new qualifying trade, or carrying on R&D from which such a trade will be developed.
- Relief can only be claimed when 70% of the money raised has been spent on qualifying activities. The certification process required for SEIS differs from EIS.
- Where money is raised under SEIS 70% of it must be utilised before any investment can be made under EIS or by a venture capital trust.
The Investor's Net Exposure - Relief for Losses
The comments below are based on the example set out in “The Investor’s Net Exposure” section in Part 1 of this note.
An SEIS investor who obtains 50% SEIS tax relief on the investment of £10,000 should be able to secure 45% income tax relief (i.e. assuming the loss arises after 5 April 2013) on the balance of the investment (if the investment is totally lost and if the investor is a higher rate taxpayer), resulting in total income tax relief of £7,250. This equates to a 27.50p in the pound overall effective loss (better than the EIS figure of 38.50p in the pound).
If the SEIS investor also secured a 28% CGT saving on 50% of the SEIS investment, by reinvesting £5,000 of capital gains realised in 2013/14 in the SEIS investment, then the total SEIS tax savings secured by the investor will be £7,250 + £1,400 = £8,650. This equates to a 13.50p in the pound overall effective loss.
The availability and extent of additional loss relief will be dependent on the facts of each case.
Why choose SEIS rather than EIS?
- 50% income tax relief rather than 30%.
- Executive directors cannot usually claim EIS but could use SEIS if they can keep within the 30% restriction. Founder shareholders who own no more than 30% will therefore often be able to participate in a SEIS funding, whereas they would typically not be able to use EIS.
- The SEIS CGT holiday provides an exemption from CGT in relation to the asset which is sold (for gains of up to £50,000), whereas reinvestments into EIS shares are only a deferral.
- A SEIS investment which is lost (due to failure of the business) should result in a lower net loss for the investor than EIS.
- However, SEIS has much lower financial limits than EIS and the same degree of complexity as EIS.
- SEIS offers no solution to the problem of putting a value on shares in a seed stage business, noting also that seed investors will often want significant equity stakes but cannot have an interest of more than 30%.
- Commercially, investors may continue to prefer to invest in companies which have got beyond the start-up stage and which can demonstrate a proven concept and some traction. The EIS limits on the size of an eligible company allow for a relatively well established company to secure EIS funding.
- A SEIS investment cannot be made after an EIS investment has been made; but EIS can follow on from SEIS provided at least 70% of the cash raised under SEIS has been spent. So, if there is a good reason for a new venture choosing SEIS rather than EIS, this does not prohibit use of EIS for a later funding round. A SEIS investor who has been a paid director can make a subsequent EIS investment provided the EIS investment is made within three years of the SEIS investment.
Appendix 1 - EIS
The main conditions to be satisfied, which are common to all three forms of EIS relief (CGT deferral, income tax and CGT exemption), are as follows (defined terms being mentioned in italics):
- the shares must beEligible Shares;
- the shares must be issued by aQualifying Company;
- the shares must be acquired by subscription (i.e. new shares issued by the company and not a transfer of existing shares);
- the subscription must be wholly in cash;
- the shares must be fully paid at the time of issue;
- the shares must be issued to raise money for the purpose of aQualifying Business Activityof the company or one of its 90% subsidiaries; relief is not available if the money is raised to acquire shares in another company;
- the money raised by the issue must be employed wholly for theQualifying Business Activitywithin two years of the issue of the shares or, if later, within two years of commencement of theQualifying Business Activity; and
relief is not available if the total of the tax advantaged Venture Capital Investments made in the company
- Eligible Shares: New ordinary shares which carry no present or future preferential right to dividends or to the company’s assets on its winding up and no present or future right to redemption. For shares issued on or after 6 April 2012 preferential dividend rights will be permitted provided the amount and timing of the dividend cannot be varied based on a decision of the company, the shareholder or anyone else and the dividend rights are not cumulative.
- Qualifying Company:
- An unquoted company (AIM companies are treated as unquoted) which exists wholly for the purpose of carrying on one or more Qualifying Trades, or a parent of a trading group where the business of the group as a whole does not consist to any substantial extent of anything other than activities which fall within the definition of Qualifying Trade.
- The balance sheet value of the company's/group's gross assets must not exceed £15m immediately before the issue of the EIS shares and must not exceed £16m immediately afterwards;
- The company/group must not have 250 or more full-time or full-time equivalent employees;
- The company issuing the shares must not be in financial difficulties in accordance with European Community Guidelines for State Aid.
- Qualifying Business Activity: a Qualifying Trade which is carried on by the Qualifying Company or a 90% subsidiary of it; or research and development carried on by the Qualifying Company or a 90% subsidiary of it, from which it is intended that a Qualifying Trade will derive. The company issuing the shares must have a UK permanent establishment.
- Qualifying Trade: Any trading activity will be a qualifying trade provided it does not consist to a substantial extent of one or more of the following:
- dealing in land, commodities or futures, or in shares, securities or other financial instruments
- dealing in goods otherwise than in an ordinary trade of wholesale or retail distribution
- banking, insurance or any other financial activities
- leasing or letting or receiving royalties or licence fees, other than from self-created intangible assets
- providing legal or accountancy services
- property development
- farming or market gardening;
- holding, managing or occupying woodlands, any other forestry activities or timber production
- producing coal
- producing steel
- operating or managing hotels or comparable establishments or managing properties used as a hotel or comparable establishment
- operating or managing nursing homes or residential care homes or managing properties used as such
- with effect from 6 April 2012, any trade which consists of generating or exporting electricity for which feed-in-tariffs are obtained; or
- providing services or facilities for any trade which consists to a substantial extent of the activities listed above and carried on by another person (other than a parent company) where one person has a controlling interest in both trades.
- Venture Capital Investments: investments which attract EIS income tax relief, investments made by venture capital trusts and investments made under the corporate venturing scheme.
Appendix 2 - SEIS
The main conditions to be satisfied to secure SEIS are:
Definition of seed stage company
- the company has gross assets of no more than £200,000 when shares issued and fewer than 25 employees;
- the shares are issued within two years of commencement of the business;
- maximum amount company can raise under SEIS is £150,000 and company must not previously have had EIS or venture capital trust investments;
- company’s main purpose must be to carry on a new qualifying trade and there must be a genuine new venture;
- the company must be unquoted with aUKpermanent establishment; and
- the company must not be in difficulty (financial health requirement) when shares are issued.
Definition of qualifying investor
- cannot be an employee of the company unless also a director;
- cannot have an interest greater than 30% in the equity of the company and must not “control” the company (loans do not count towards the 30% test but care needs to be taken if the loan capital has any equity features and if loan repayments are envisaged within three years of the share subscription); and
- various anti-avoidance provisions apply.
Method of investing
- Must invest in new qualifying shares by way of a cash subscription – same requirements as for EIS as to type of share to be used.
- the shares must be held for three years;
- the money must be raised for qualifying business activities and must be spent on those activities within three years;
- qualifying business activities are defined as carrying on or preparing to carry on a new qualifying trade, or carrying on R&D from which a new qualifying trade will be developed (or which could benefit a new qualifying trade);
- relief cannot be claimed until 70% of the money raised has been spent on qualifying activities; the company has to provide appropriate certification to investors (and the company must first file a compliance statement with HMRC and receive authority to issue certificates to investors);
- various anti-avoidance provisions apply as with EIS (e.g. preventing situations where the investor receives loans linked to the investment and preventing pre-arranged exits and requiring the money to be raised for genuine commercial reasons and not as part of a tax avoidance arrangement);
- as with EIS, there are provisions to withdraw relief where relevant conditions are not satisfied throughout the three year period from issue of the shares and where “value is received” by investors during this period; and
- if money is raised under SEIS, 70% of this must be utilised before any investment can be made under EIS or by a venture capital trust.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.