EIS: is it right for your company?
The Enterprise Investment Scheme (EIS) offers both income tax and capital gains tax (CGT) relief to investors in qualifying companies. But there can be drawbacks for investors and companies alike. Find out if the benefits suit your business.
EIS is a series of tax reliefs designed to encourage investment in small unquoted companies carrying on a qualifying trade in the UK. 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 from EIS 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 But EIS rules can be quite complex, and there are traps for the unwary which may lead to relief being denied or withdrawn.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?
- Income tax relief - an investor with a maximum 30% interest in the company can reduce their own income tax liability by an amount equal to 30% of their share subscription.
- CGT exemption - shares which qualified for income tax relief are exempt from CGT if sold after three years.
The minimum subscription to qualify for both these reliefs is £500 per company. The maximum per investor is £500,000 per annum (increasing to £1m per annum from 6 April 2012). 'Connected persons' are taken into account in considering these thresholds and the 30% interest limit.
- CGT deferral - capital gains liabilities incurred on any other disposals in the 36 months before the EIS investment, or the 12 months following it, can be deferred until the eventual sale of the EIS shares. This relief is not dependent on income tax relief, and there is no maximum investment.
If EIS shares are disposed of at any time at a loss, and initial income tax relief is not wholly withdrawn, the losses arising can be set against the investor's capital gains or income in the year of disposal.
What are the qualifying criteria?
The issuing company must be a trading company, carrying on its activities in the UK. This extends to the parent company of a trading group, or a company carrying on research and development activities - but not all trades qualify. A company preparing to carry on a qualifying trade may also benefit.
The investor must otherwise be unconnected with the issuing company. This prevents employees from qualifying for relief, although directorships are permitted. An investor may not claim EIS relief on shares in a company whose qualifying trade is one they themselves carried on before the investment.
Other conditions
- Shares must be issued in return for new cash introduced to the company. A capitalisation of an existing loan account will not qualify.
- The funds from the share issue must be used for the purposes of a qualifying trade, either carried on by the issuing company or a 90% subsidiary, within 24 months of subscription.
- The issuing company's gross assets must not exceed £7m before, or £8m immediately following, the issue of EIS shares (increasing to a maximum of £15m before issue from 6 April 2012).
- There must be no 'exit route' provided to incoming shareholders at the time of their investment.
Ongoing requirements
The company (or a qualifying 90% subsidiary) must continue trading for three years following the share issue, otherwise income tax relief will be withdrawn and any relief obtained will be repayable.
During the three-year period following investment, the qualifying investor cannot receive any 'value', otherwise their relief will be withdrawn. 'Value' includes significant rent, interest, salaries or dividends, where these exceed commercial amounts, together with the repayment of share capital or loan advances.
Relief may also be withdrawn if value is provided to any other investor during the three- year period - as repayment or repurchase of share capital. This restriction also extends to the 12 months before the share issue.
It is the responsibility of the EIS company to inform HMRC of any changes in the company, or if value is received by any party.
If shares are disposed of within the three-year period, the CGT exemption will not apply, and any income tax relief previously obtained is clawed back.
Is EIS suitable for you?
It's clear an EIS qualifying company could offer significant benefits to an investor by reducing the effective cost of his investment. At a time when companies are struggling to source new investment, this may offer a competitive advantage.
Unfortunately though, the rules for EIS can be restrictive. An incoming investor may wish to have a controlling interest in a company, particularly an unproven start-up, but the 30% investment limit will prevent this. The ongoing restrictions may present conflicts between the interests of the company and the desire for investors to retain their EIS status, particularly during the qualifying period. Investors may be uncomfortable that they cannot plan their exit strategy from the outset.
Notwithstanding these issues, EIS can provide significant benefits to both the company and its investors. If you would like to discuss how EIS can work for your new (or existing) company, contact Chris Riley on 020 7516 2427 or by email criley@littlejohnllp.com
