The Benefits of the SEIS and EIS scheme
The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are HMRC venture capital schemes designed to incentivise investment in small, early stage businesses. EIS is long established whereas SEIS was introduced more recently in order to incentivise smaller start-up businesses who wish to raise funds of up to £350,000.
Benefits of the schemes
Under both EIS and SEIS, investors in qualifying companies, which use the invested funds for a qualifying trade, can get immediate income tax relief of 30% and 50% respectively on money invested. with a future capital gains exemption on the sale of shares after three years (on the basis that income tax relief was claimed and not withdrawn). There is also the potential to defer other capital gains through EIS/SEIS reinvestment of the proceeds.
Furthermore, shares issued under both the EIS and SEIS schemes are exempt from inheritance tax once they have been held for a two year qualifying period.
What are the differences between SEIS and EIS?
In order to benefit from the generous reliefs available (particularly income tax relief), the company raising the funds must meet a number of conditions as follows.
SEIS focuses on helping fund fledgling companies, being defined as privately owned businesses which have been trading for less than three years, have gross assets of less than £350,000 and fewer than 25 full-time equivalent employees.
EIS is designed to help fund companies that are slightly older than SEIS qualifying companies, however are still relatively new. An EIS qualifying company is broadly defined as a ‘small’ private company that, in most cases, has been trading for less than seven years, has gross assets of less than £15m, and fewer than 250 full-time equivalent employees. If a company is highly innovative and/or actively engaged in research and development, it may raise additional financing than is ordinarily available under the scheme, whilst the employee and gross asset thresholds mentioned above are increased.
For each scheme the investor must not have been a paid employee of the company (although for SEIS they may be a paid director) and must not have a 30% interest in the company. The 30% test is subject to detailed rules and also brings into account the interests of other family members and associates.
With both schemes there must be a genuine risk associated with the investment to qualify, and the new shares themselves cannot have any favourable rights attached to them.
What are the potential pitfalls
The tax reliefs available under both schemes are very generous and whilst founders may be reasonably comfortable with the rules, they are inherently complex and reliefs can be inadvertently lost. Below are some common issues we encounter, however there are many more!
- The investor shares must be fully paid up at the time they are issued and be subscribed for wholly for cash. Making an investment up front without shares being issued could be treated as a loan satisfied by the later issue of shares. In cases such as these, relief will be denied.
- The funds raised under each scheme must be utilised within given timescales for the purposes of the qualifying business activity. Using the amounts to repay loans or to acquire interests in other companies or trade and assets would not meet this test and prevent relief being available.
- The company must carry out a qualifying trade for at least 3 years after the investment is made otherwise EIS or SEIS relief will be withdrawn. Therefore if the business branches out or in any way expands its scope of operation then the excluded activities rules should be considered carefully.