EIS and SEIS are two of the most valuable forms of tax reliefs open to investors, worth up to 30% and 50% of the investment respectively.
Even so, they are not investments for the faint hearted: The sort of companies that qualify for these (especially for SEIS), tend to be new, high risk ventures that may or may not be successful. EIS and SEIS reliefs are the Government’s way of making these investments a little bit more attractive. If you are thinking about starting up a new company, or have already done so, SEIS and EIS can be a great way to tempt in new investors. There are restrictions over the sorts of companies that will qualify, but typically most smaller trading companies will be eligible for one or other of the schemes. Property investing, accountancy services, banking, farming and leasing are among those activities that are however excluded.
The reliefs for the investor
The headline relief that tends to attract investors into making investments in EIS qualifying companies is the 30% income tax relief available, which applies irrespective of the investor’s marginal rate of tax, so long as they have paid enough tax to reclaim it. The claim can be made against income tax in the year of the investment, or carried back to the previous year.
The maximum investment that can be relieved in any tax year is £1million per investor.
In addition to income tax relief, EIS investments qualify for two separate CGT reliefs: First, there is no CGT on any gain made on their disposal as long as the shares are held for the qualifying period. Second, gains made in the year before or up to three years after the investment is made can be deferred against the EIS investment. This applies to any asset that has been disposed of. The original gain crystalises when the EIS shares are disposed of, or if the tax payer becomes non-resident or the investment ceases to qualify.
If shares are disposed of at a loss, income tax relief is available, insofar that the value has not already been relieved – i.e. not the 30% upon which income tax relief has already been given.
In order to qualify for any of the reliefs, the shares need to be retained for broadly 3 years.
The reliefs available for SEIS investors are even more generous than under EIS, but this is due to the riskier nature of companies that qualify.
The income tax relief rate is increased from 30% to 50%, again, irrespective of the tax payer’s marginal rate. Again this is subject to the total tax liability for the year.
The CGT reliefs are also more generous and are once more, two fold. Like EIS there is no CGT due on a disposal after the qualifying period. However, instead of deferral relief, SEIS shares qualify for Reinvestment Relief – any gains made on any assets disposed of in the same year as the SEIS income tax relief is claimed can be relieved entirely, subject to a cap of 50% of the amount invested.
Again, if the shares are sold at a loss, the loss will qualify for relief against income tax.
For investments made prior to 2013/14, the combination of income tax and capital gains tax reliefs could lead to overall relief of over 100% of the amount invested, but sadly HMRC have noticed and the total reliefs now available have been reduced somewhat but are still impressive: if the company fails and all reliefs are claimed the risk is restricted to just 13.5% of the amount invested. The total saving is much higher still if the company flourishes and the shares are sold at a profit. So, while the companies that qualify are risky, the risk to the investor is mitigated somewhat by the reliefs available.
Qualifying as an investor
In order for your investment to qualify, you will need to meet several conditions. The conditions for EIS and SEIS are similar, but not identical.
For both EIS and SEIS, the investment must be wholly for cash, fully paid up at the time the shares are issued. Converting a loan that you have made to the company at an earlier date is not allowed.
In both cases, you and your associates (spouse, civil partner, parents, children) cannot hold more than 30% of the share capital between you. Siblings are not associated for this purposes, so a company owned jointly between four siblings would qualify.
For EIS, you cannot have been an employee or director of the company before the investment. Once you have shares, you may accept appointment as a director.
For SEIS, the rules are more relaxed. You can be an employee of the company, but only if you are also director. None of your associates can be employees though.
Within the first three years of either investment, you cannot ‘receive value’ from the company. The definitions are quite widely made, and this will restrict investors who have made loans to the company before they have invested in qualifying shares from having the loan repaid to them within the three year qualifying period. This rule also prevents “excessive” payments from being made to investors by way of a salary or similar, although market rate payments for services are generally permitted, as are dividends, if the company can afford to pay them.
Qualifying as a company
In both cases, the company must be unquoted (although being quoted on AIM is acceptable). In order to be able to issue SEIS shares, the company needs to be less than two years old and very small – less than 25 employees, and with assets of less than £200,000.
EIS is available to older, slightly larger companies. The size restrictions include having gross assets of less than £15million before the investment and £16million after, and having fewer than 250 employees.
In both cases, the money must be raised for a qualifying purpose, and all the money raised must be spent within two years of the date of issue (or commencement of the trade if later). The shares issued must be Ordinary shares that are not redeemable for at least three years. There can also be no pre-arranged exit route for the investor.
The lifetime cap for a company issuing SEIS shares is £150,000. The maximum for EIS is much higher – the company cannot raise more than £5million in any year (the combined total between SEIS, EIS and VCT investments) and is restricted to £12million in the company’s lifetime.
If you are considering using both SEIS and EIS, SEIS must always be done first – the moment that you begin to issue shares under EIS, the ability to issue SEIS ends. Since April 2015 it has been possible to start issuing EIS shares as soon as the company’s SEIS maximum has been reached – prior to this the company would have had to have spent at least 70% of the money raised under SEIS before EIS shares could be issued.
EIS and SEIS can usually be applied for at the same time, which speeds things up as there is a certain amount of overlap in the information HMRC needs to give that clearance.
The process for applying for SEIS and EIS (from the company’s perspective) is made up of three steps.
Step 1 – Advanced Assurance is applied for. This is not compulsory but highly recommended. Form EIS/SEIS (AA) is submitted to HMRC along with detailed information about how the company plans to use it investment fund and various confirmations about how the company meets the qualifying conditions. HMRC have 30 days to respond to the application, or to ask additional questions.
Hopefully at this point, HMRC will grant Advanced Assurance that the company and investment will qualify. HMRC will not confirm that any individual investor will qualify specifically.
Step 2 – Once the company has spent 70% of the funds, orhas been trading for 4 months, if this is earlier, a Statement of Compliance (form EIS/SEIS 1) is completed and sent to HMRC. The form provides HMRC with full details of each investment and investor.
Step 3 – Once HMRC have approved the form EIS/SEIS 1, they will provide certificates to be completed for each Investor. The investors can then use this to claim relief, either via Self-Assessment for the current year or year before, or they can contact HMRC to make adjustment to their PAYE code if preferred.
SEIS and EIS are both very generous tax reliefs but there are plenty of pitfalls on the road to qualifying and so expert tax advice should always be sought as soon as possible in the process to ensure that none of the rules have been inadvertently breached before you have even started.
Please contact the author or our tax team if you would like to discuss this further or any other opportunities.