This short guide summarises the various tax reliefs that are available through EIS together with the criteria that must be satisfied by the investor and the company recovering the investment in order to ensure that the investment will qualify for the various tax reliefs.
There are four possible tax benefits available through EIS:
- Income tax relief – 30 per cent of the cost of the investment (which must be the acquisition of Shares defined below) may be offset against a qualifying investor’s income tax liability in the tax year in which the Shares are acquired. There is also a carry back facility that allows the Shares to be set off against income tax liability in the preceding year, subject to the £300,000 maximum level of income tax relief per tax year.
- Capital Gains Tax (CGT) relief – No CGT is payable by an investor on the first disposal of the Shares.
- Loss relief – If an investor incurs a loss on the first disposal of the Shares, this capital loss (after deduction of income tax relief) may be set off against income in the tax year of disposal or the previous tax year, rather than against capital gains.
- Deferral relief – CGT arising from the disposal of any asset can be deferred by investing that capital gain in EIS Shares, for a period commencing one year before and ending three years after the disposal. The original CGT that is deferred will be payable on the disposal of the EIS Shares.
Deferral relief is not subject to the annual investment limit and the connected person test, outlined below, and the investor does not have to hold the Shares for a period of three years following subscription in order to obtain this relief.
In order to take advantage of the benefits of the EIS scheme both a qualifying company and a qualifying investor must meet the following conditions.
In order to qualify, the Company:
- must issue full-risk ordinary shares carrying no preferential rights* to dividends or assets on winding up and which are fully paid up in cash (the “Shares“). Shares may not be issued as a result of capitalisation of debt
- must be unquoted when the Shares are issued
- must be a ‘small’ company which means that it does not have assets exceeding £15m preceding and £16m following the issue of the Shares and that it has less than 250 full-time employees
- must not raise more than £5m in any given tax year (up to a lifetime limit of £12m) through either EIS, the Seed Enterprise Investment Scheme (SEIS), Venture Capital Trust (VCT) schemes or Social Investment Tax Relief investments. This is assessed on a group wide basis.
- must not be the subsidiary of or controlled by another company and if the company receiving investment has any subsidiaries, these must be at least 50 per cent owned by and under the control of that company
- must carry on a qualifying trade either itself or through a 90% subsidiary. A ‘qualifying trade’ means most trades that are conducted on a commercial basis with a view to making profits, provided it is not an excluded activity (unless that excluded activity does not amount to a substantial part of the company’s trade). A ‘substantial part’ of the company’s trade is deemed to mean more than 20 per cent of the company’s trade.
Examples of an ‘excluded activity’ include dealing in land or shares; property development; money-lending, insurance and other financial activities; dealing in goods, other than ordinary wholesale and retail trades; leasing or letting assets on hire; receiving royalties or licence fees, other than those attributable to intangible assets created by the company; farming and market gardening; forestry; and operating or managing hotels, guesthouses, nursing or residential care homes. This acquisition of existing shares in another company or assets that have been used for the purposes of a trade are also specifically excluded from being a qualifying business activity:
- must have a permanent establishment in the UK throughout the period starting with the issue of the shares and ending three years later. Provided the issuing company has such a permanent establishment, the money raised under the EIS subscription can be used for the purpose of its qualifying trade (even if not carried on in the UK);
- must issue the Shares within seven years of its first commercial sale (with some exceptions, such as follow on funding or investment matching or exceeding the company’s annual turnover);
- must issue Shares to promote the “growth and development” of the company. This means there needs to be some evidence of a long term plan for the company beyond a single project;
- must apply the money raised from the issue of Shares towards a qualifying trade within two years of the issue, or two years after commencement of trading, whichever is the later.
The Shares must not be issued in connection with, or as a consequence of, particular “disqualifying arrangements” which generate access to the reliefs where the benefit of the investment is passed onto another party or where the business activity would otherwise be carried on by another party.
There must also be no arrangements at the time of the share issue for the Shares to be sold, exchanged or otherwise disposed of at a later date or any other arrangements designed to reduce the risk attached to the investment.
- must not be ‘connected’ to the Company for a period of two years before and three years after purchasing the Shares. This means that he/his associates must not:
– be an employee, partner or paid director of the Company
– or control or own more than 30 per cent of the Company.
‘Associates’ are defined as business partners, trustees of a settlement where the investor is settlor or beneficiary and the Investor’s lineal family (which does not include brothers and sisters)
- must not dispose of any of his Shares in the company (unless this is to his spouse)
- must not receive any value from the company
- may invest a maximum of £1,000,000 in multiple qualifying companies in any tax year.
EIS relief is provisional and may be withdrawn if during the period of three years from the issue of the Shares an event takes place which contravenes any of the above conditions governing relief.
For further information, please view our ebulletins on EIS and EIS fundraising.
The content of this note does not constitute legal advice and should be treated as general guidance only.
*The Finance Act 2012 allows the shares to carry a preferential right to dividends, providing the dividend amount and the date dividends are payable is not dependent on a decision of the company, the shareholder or anyone else and providing the dividends are not cumulative.