The Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) provide significant tax incentives for external investment into developing technology companies. They primarily appeal to individual angel investors but can also apply to individuals investing through trust arrangements.
- Immediate income tax relief of up to 50% available on investment
- Future capital gains exemption on disposal of investment
- Potential to defer other capital gains through EIS/SEIS investment of proceeds.
For both EIS and SEIS, the tax reliefs divide into three different categories, these being income tax reliefs, capital gains tax reliefs and an exemption from inheritance tax.
The income tax reliefs
Essentially, both schemes are directed at third party investment in unquoted trading companies. They are particularly relevant to developing high growth technology companies. Such companies typically seek external investment at a time when bank financing may be difficult to obtain.
It is a requirement that the company raising the funds must carry on a qualifying trade, and have an establishment in the UK. In addition the company must not be in financial difficulty at that time of the investment.
Rules applicable to EIS and SEIS schemes
It is very important that the investor does not start with making a loan to the company with a view to converting it into an issue of shares at a later time. An investment under the scheme must raise new funds for the company and cannot be made in exchange for an amount of loan previously made. The shares must be paid for immediately on issue.
It is also necessary to follow certain procedures in order to claim the relief. In relation to any investment, the company must approach a specialist office within HMRC in order to have the EIS claim approved, and once that is given HMRC will issue the necessary claim form to be submitted with the tax return for the year of investment.
After an investment is made, there remains a qualifying period of three years throughout which there must be no return of value to the investor from the company. Return of value is widely defined to include the redemption of shares or securities, loan repayments and certain other types of payment not listed as being acceptable. This does not however prohibit dividends being paid on the shares.
If the investment should prove to be unsuccessful and ultimately a loss arises on the disposal of the shares, that loss can be claimed for income tax relief. The loss will be the amount of the investment, less the amount of income tax relief which was received. Accordingly, if an EIS investment is now made of £100,000 for which £30,000 of income tax liability is relieved, should the investment prove to be a total loss, an amount of £70,000 can be claimed in the year of loss as a deduction from taxable income. For a 40% taxpayer, this will mean that most of the loss is covered by tax relief, which is £30,000 on investment, and £28,000 on the ultimate loss claim, a total of £58,000 in tax relief.
The capital gains tax reliefs
There are principally two capital gains tax reliefs for EIS and SEIS investments.
Firstly, shares which qualified for income tax relief and which are retained for the three year qualifying period; they then become exempt assets for capital gains tax purposes. Accordingly, if they are realised at a profit, that profit will be tax free.
The second capital gains tax relief is that the amount subscribed for the shares entitles you to hold over an equivalent amount of capital gains. The qualifying subscription for EIS shares has to have been made within one year before or three years after, the disposal. Hold over relief is a mechanism by which the gain realised on an asset can be deferred so that tax is not payable for the year of disposal, but becomes payable when the EIS shares are disposed of.
This EIS deferral relief is not subject to the same detailed conditions that apply to the EIS income tax relief. For example, deferral relief applies even if the EIS company is your own wholly owned trading company. You can hold over the gain on any asset into a subscription of shares in a new trading company which you may set up or alternatively into an issue of further shares in an existing trading company which you already run. 100% of the money raised from the subscription must genuinely be used for the purposes of a qualifying trade within 24 months.
Reinvestment relief is available for SEIS investments, which can act to exempt 50% of a reinvested gain.
The inheritance tax exemption
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. There is no limit on the value of the shares qualifying for this exemption. Furthermore, there is no recapture of any of the other tax reliefs detailed above on the death of the taxpayer concerned.
The inheritance tax exemption for EIS and SEIS shares applies to gifts of the shares both on death and in lifetime. In principle therefore shares acquired under either scheme can, after the three year be used to shelter gifts of other assets into a family trust made in lifetime.. This procedure does however require detailed advice.
For the purposes of the EIS scheme, shares quoted on the alternative investment market count as unquoted and therefore if a subscription can be arranged into shares on that market, subject to the other detailed conditions for relief, those shares may qualify for the EIS income tax and capital gains tax reliefs as well as inheritance tax exemption.
The tax reliefs available under both enterprise investment schemes for investors into qualifying technology companies are very generous, albeit that investments into companies of this size are inherently risky. No investment should be made solely for tax reasons. Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.
If you require any further information on any of the issues raised above, please contact Menzies Partner and head of Technology Stephen Hemmings by phone on 0207 465 1968 or by email at firstname.lastname@example.org.