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Enterprising investment - the Enterprise Investment Scheme (EIS) - 2011-11-18

The Enterprise Investment Scheme (EIS) is a series of tax reliefs designed to encourage investment by individuals in small unquoted companies carrying on a qualifying trade in theUK. It can be of particular interest to investors in start-up companies, but is equally applicable to established companies if the conditions are met.

The decision to make any investment should, of course, be governed primarily by commercial factors, with any taxation benefits considered second. But EIS rules can be quite complex, and there are traps for the unwary which may lead to relief being denied or withdrawn.

What are the reliefs?

There are two main aspects to EIS relief and a single qualifying investment will qualify for both - an Income Tax repayment of 30% of the subscription value in newly issued shares, and an exemption from Capital Gains Tax when these shares are disposed. There are however strict conditions which must be met to ensure these reliefs are available and not subsequently withdrawn.

The initial qualifying criteria

EIS relief is only available for investments in newly issued shares in trading companies, or the parent companies of 90% subsidiaries which carry on a qualifying trade. The company issuing the shares must itself have a “taxable presence” (i.e. a permanent establishment) in theUK. Some trades do not qualify, but the definition of trading does include companies carrying on research and development activities and companies preparing to carry on an otherwise qualifying trade.

The investor must be unconnected with the company. This rule prevents employees from qualifying for the relief, however there are relaxations for directors. Additional rules prevent an investor from claiming EIS relief on shares in a company which carries on the same business that the investor previously had an interest in.

To qualify for EIS relief, at least £500 must be subscribed for new shares in a company, but the investor cannot take more than a 30% interest. An individual can make up to £500,000 of qualifying EIS subscriptions in one or more EIS companies per year.

There are also size limits in respect of the issuing company/group, which must not itself be controlled by another company, and there must also be no pre-planned mechanism provided to incoming shareholders to allow them to dispose of their investment.

Other considerations

In essence, EIS relief is aimed at encouraging new investment in companies which will use the money raised to expand and develop the business. The rules therefore require new funds to be introduced, rather than recycling existing loans or capital. The new funds raised must be used in the trade within 24 months of subscription.

During the three years following investment, the company must continue carrying on a qualifying trade. The investor cannot sell their shares nor can they receive any ‘value', such as repayments of loans or share capital, or other payments in excess of commercial rates from the company during the same period. Similar rules prevent a return of capital to other shareholders during the three year period.

If any of these (or further) conditions are not met, relief will be withdrawn and any income tax relief previously received will become repayable in full. Any share disposals will be subject to Capital Gains Tax.

An investor may additionally be able to reinvest the proceeds of other capital disposals in new EIS shares and defer the liability to Capital Gains Tax until the new shares are sold. The rules regarding this relief are generally less restrictive than for the main reliefs.

Is EIS suitable for you?

An EIS qualifying company can offer significant benefits to an investor but the rules can be restrictive. A decision to apply for EIS rests with the company concerned, and the limitations imposed by the EIS may require careful balancing of the individual ambitions of those investors qualifying for EIS compared with other investors.

Whether the restrictions outweigh the potential tax benefits of applying for EIS status for a particular investment can only be determined on a case by case basis.

The complexity of the EIS means that this article can only provide a overview of the relief and conditions. If you would like to discuss in my detail how EIS can work for you or your company contact Chris Riley on 020 7516 2427 or by email criley@littlejohnllp.com

This article was first published in Waterfront magazine, November 2011.