By Lesley Stalker, tax partner at Surrey accountancy firm RJP LLP
The opportunity for companies to attract external capital investment through the tax advantaged EIS and SEIS schemes has made a huge difference to SMEs and startups over the years. It may appear hard work to secure the required advance assurance, but thousands have benefited since EIS was first launched in 1994.
Data released most recently from HMRC in October 2017 suggests that well over 5,500 companies have received funding through the two schemes, with investment secured totaling more than £1.8bn. Clearly the tax breaks offered to higher rate taxpayers willing to invest in smaller companies are providing a strong incentive and crowd funding specialists like Crowdcube have made the whole process more accessible.
If you are not familiar with the basic rules surrounding EIS and SEIS, they are as follows:
To qualify for EIS, a company must be unquoted, have fewer than 250 employees and assets of less than £15m. The maximum amount a company can raise through EIS in a single financial year is £5m. In the case of SEIS, the company must have fewer than 25 employees, gross assets must not exceed £200,000 and a company can raise maximum investment of £150,000 in a three-year period. Multiple funding rounds can be completed, so a start-up can begin with SEIS investment and then progress to EIS, provided they meet the qualification criteria.
Individuals can invest up to £1,000,000 in EIS companies in a tax year and receive 30% income tax relief. Provided they maintain the qualifying investment for at least 3 years, any gain made on disposal is tax free, although losses are allowable. Investors can also defer paying tax on other capital gains made within certain time limits of the investment.
For SEIS, the tax breaks are more generous, albeit the investment limits are much smaller; investors can receive initial tax relief of 50% on investments of up to £100,000 along with full CGT exemption and a generous deferral relief.
Beware the pitfalls that can invalidate pre-approvals
All of this appears very straightforward on the surface, but there are some pitfalls which can result in the tax advantaged status of an investment being invalidated. In financial terms, this could mean that the investor loses their entitlement to the tax reliefs expected and the company may not get the funding needed for growth.
Here are some of the most common traps:
- EIS relief is not available for share issues in companies that have been trading for more than seven years unless certain conditions are satisfied. These conditions should be checked carefully;
- EIS income tax relief will be lost if an investor is ‘connected’ with the company e.g. they are an employee or director with more than 30% share capital or voting rights. This includes the rights of business partners and certain family members (e.g. spouses and civil partners, parents, children, grandparents and grandchildren). Note, these restrictions are more relaxed for SEIS investments and there are also exceptions for Business Angels who are unremunerated;
- Shares must be issued and dated correctly. This means that if a company is raising funds through both schemes, SEIS shares need to be fully issued at least one day ahead of EIS shares. Mistakes made when the shares are issued are not easy to correct;
- Keep a record of everything, with proper supporting documentation filed at Companies House. It’s always good practice to have well-kept records anyway. For SEIS/EIS share issues, this should include amongst other things, a written shareholders’ agreement, board meeting minutes documenting the issue of SEIS/EIS shares and official share certificates;
- For companies, ensure payment is received in full for the shares before issuing any share certificates; investors should ensure they have paid for the shares before the date on their share certificate. If this doesn’t happen in the correct order, the EIS/SEIS approval granted by HMRC can be invalid;
- An investor must have taxable income which is at least equal to the investment made for tax relief to be available in full in the tax year;
- The company must be in a qualifying business when the shares are issued and companies can get caught by this rule if they have changed strategy since they first applied for advance assurance;
- Finally, the cap on EIS shares issued is £5 million and some companies have been caught in the past by EU State Aid rules for exceeding this amount because of Euro/Pound currency fluctuations. This is a less common pitfall but nevertheless, it’s prudent to stay below this level.
To find out more about getting funding for your business through EIS, or how becoming an EIS investor could become part of a personal tax planning strategy, please contact us directly via firstname.lastname@example.org.