Tax has the potential to impact on all aspects of both setting-up and running your business. Considering tax issues from the outset can ensure that your business is established in the most tax efficient way for both you and your investors. It is also important to consider tax issues going forward to ensure that you are complying with all of the relevant tax law requirements and making the most of any available reliefs and other opportunities to maximise the tax efficiency of your business.
The notes provide a general introduction to some of the tax issues that may be relevant to your business and some of the changes in law that have been proposed recently, but there are many more! You should always take specific advice as tax law and tax rates change regularly
The Enterprise Investment Scheme
The Enterprise Investment Scheme ("EIS") offers tax incentives to individuals investing in small, high risk trading companies. The purpose of the scheme is to help those companies which might otherwise struggle to raise equity finance.
This note covers the basics of how the scheme works, what tax relief is available and who can qualify for the scheme.
How does the scheme work?
The scheme provides income tax and capital gains tax reliefs for individual investors who subscribe in cash for ordinary shares in qualifying companies.
For shares issued on or after 6 April 2011, an investor who qualifies for the relief can claim an income tax reduction equal to 30% of the money subscribed. The relief is subject to an annual subscription limit which, for shares issued on or after 6 April 2012, is £1,000,000, so the maximum tax reduction for the 2012/13 tax year is £300,000 (the annual subscription limit for shares issued in the 2011/12 tax year was £500,000).
For example, if an investor subscribes £50,000 for shares and claims EIS relief, he or she can deduct £15,000 from their income tax liability for the year (although EIS relief can only be used to the extent that they have an income tax liability, it cannot create a loss or a repayment of tax).
For shares issued on or after 6 April 2012, the annual investment limit is increased to £1,000,000, so the maximum income tax reduction for the 2012/13 tax year is £300,000.
Capital gains tax
Provided the shares have been held for the requisite period of time (which is discussed later in this note), any gain made by the investor on a disposal of EIS qualifying shares is exempt from capital gains tax.
There are also special rules which allow losses incurred on the disposal of EIS qualifying shares to be set against an investor’s income tax liability.
How long do the shares have to be held for?
To benefit from full income tax relief, EIS shares must be (broadly) held for at least three years after the date of their issue. If an investor disposes of EIS shares within three years of their issue, then the EIS income tax relief is withdrawn by reference to the proceeds that the investor receives.
The effect of this is that, if an investor sells his EIS qualifying shares within three years of their issue for an amount equal to or greater than the money he subscribed for them, his EIS relief would be fully withdrawn.
In addition, if an investor sells his EIS qualifying shares within three years of issue, then any gain ceases to be exempt from capital gains tax.
Are there restrictions on who can be a qualifying investor?
As the purpose of the scheme is to incentivise external investment in small, high risk trading companies, the scheme is not generally available to directors and employees of those companies. However, in recognition of the fact that companies qualifying for EIS can often benefit from the business experience of their investors, there is an exception for directors who do not receive remuneration from the company or who have not prior to their investment been involved in the company’s trade.
There are also limits on the size of shareholding that an investor can take. EIS relief is not available to investors that hold (directly or indirectly) more than 30% of the company’s ordinary share capital or voting rights. Prior to 6 April 2012, there was a restriction on the amount of the company's loan capital which could be held by an investor. This restriction was removed for shares issued on or after 6 April 2012.
Which companies qualify for EIS?
The scheme is only available to companies which meet certain qualifying conditions, the purpose of these conditions being to restrict the scope of the scheme to those companies which may otherwise struggle to secure financing. For shares issued on or after 6 April 2012, the main conditions are:
- the company must have a UK permanent establishment;
- the company must carry on a qualifying trade on a commercial basis. Companies carrying on certain excluded activities, including (amongst others) dealing in land, property development and banking, are not eligible for the scheme;
- the company must not be listed on a recognised stock exchange (although a company quoted on the Alternative Investment Market can continue to qualify for the scheme);
- the company must not be controlled by another company;
- the company must have gross assets of no more than £15 million before the investment and no more than £16 million immediately after the investment; and
- the company must have fewer than two hundred and fifty full time employees.
In addition, companies can only raise a maximum of £5 million in aggregate under the EIS, the Venture Capital Trust Scheme (a separate scheme which provides tax benefits for indirect investment in small trading companies through a form of fund known as a Venture Capital Trust) and certain other State aid investments on a rolling 12 month basis.
Where investment is made after a company has raised funds under the new "Seed enterprise investment scheme" (SEIS), the new investment may only qualify for EIS tax relief once at least 70% of the SEIS investment monies have been spent in the company's qualifying activity.
As part of the Government’s commitment to encouraging entrepreneurship and investment in smaller, higher risk trading companies, a number of changes were introduced to the EIS rules for shares issued on or after 6 April 2012, aimed at widening access to the scheme. This includes allowing shares carrying certain limited preferential rights (not including preferential rights to assets on a winding up, cumulative dividends or dividends where the amount or timing of the dividend depends on a decision of the company or another person) to qualify for EIS.
Further anti-avoidance provisions now apply to shares issued on or after 6 April 2012 through the introduction of a "no disqualifying arrangements" test. The test excludes any arrangement from qualifying for relief if it is entered into with the purpose of ensuring that the relevant tax relief is available AND either: (a) all or most of the monies raised are to be paid for the benefit of a party to that arrangement; or (b) it would be reasonable to expect that, absent the arrangement, the business would be carried on as part of another business. In the latter case, this means that a structure to separate part of an existing business (that would not qualify) so that investment into that part, taken alone, can qualify for relief is no longer effective.
"To benefit from full income tax relief, EIS shares must be (broadly) held for at least three years after the date of their issue. If an investor disposes of EIS shares within three years of their issue, then the EIS income tax relief is withdrawn by reference to the proceeds that the investor receives."