briefing The Enterprise Investment Scheme Tax reliefs

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1 briefing January 2016 The Enterprise Investment Scheme This nte prvides a summary f the Enterprise Investment Scheme and has been prepared based n the law up t and including the Finance (N 2) Act The Enterprise Investment Scheme (EIS) encurages investment by individuals in small unquted trading cmpanies (r via EIS funds, which are see-thrugh fr tax purpses) by ffering generus tax reliefs t such investrs. The tax benefits are attractive but cnsiderable care is needed t btain them and a range f cnditins must be fulfilled by bth the cmpany issuing the shares and the individual investr. While EIS relief is appealing, the devil is in the detail. Fr investments in new and very small cmpanies, investrs may als wish t cnsider the Seed Enterprise Investment Scheme. Tax reliefs Incme tax relief An individual investing in EIS shares can currently claim a reductin f his incme tax liability in that tax year equal t 30% f the amunt subscribed fr the EIS shares. The relief is currently subject t a maximum investment limit f 1 millin per annum. Where an investr is entitled t claim incme tax relief in respect f a subscriptin fr EIS shares made in any tax year, he may elect t carry back sme r all f the incme tax relief t the previus tax year. Capital gains tax exemptin Prvided incme tax relief has nt been withdrawn, and the EIS shares are held fr at least three years frm the date f their issue (r, if later, until at least three years after the date n which the relevant cmpany begins t trade) (that is, until the relevant third anniversary ), n capital gains tax charge arises n the sale f thse shares. Capital gains tax deferral relief An investr can ffset the amunt subscribed fr EIS shares (including subscriptins that exceed the maximum permitted fr incme tax relief) against his capital gains which arise in the perid beginning three years befre and ne year after the date n which the investr subscribes fr EIS shares. Any gain s ffset is deferred until a dispsal r ther chargeable event ccurs in relatin t the EIS shares. At this pint the earlier gain revives and the assciated capital gains tax falls due. There is n limit n the amunt f deferral relief which may be claimed. Lss relief If a capital lss is made n the sale f the EIS shares, in certain circumstances this lss (less any incme tax relief already given) can be set against incme r capital gains. By way f illustratin, fr an investr wh secures maximum tax relief, an investment f 1,000,000 can result in a tax reductin f 580,000 fr the relevant year (made up f 300,000 f incme tax relief and 280,000 f capital gains tax deferral) _1 1

2 Cnditins fr EIS relief The cmpany Unquted cmpany: The cmpany must be unquted at the time f the investment with n arrangements in existence fr its fltatin. Fr EIS purpses, a cmpany whse shares are traded n AIM is treated as unquted. Number f emplyees: The cmpany must have fewer than 250 full time emplyees (r their equivalents) when the shares are issued r 500 fr a knwledge-intensive cmpany. A knwledge-intensive cmpany is a cmpany whse csts f research and develpment r innvatin are at least 15 per cent f the cmpany s perating csts in at least ne f the previus three years, r at least 10 per cent in each f the previus three years (the three years ending immediately befre the cmpany s last accunts); and either which is engaged in intellectual prperty creatin frm which within 10 years it is expected will derive the greater part f the cmpany s r grup s business; r which has emplyees with a relevant Masters r higher degree wh are engaged in research and develpment r innvatin and wh cmprise at least 20 per cent f the cmpany s ttal full time equivalent wrkfrce. Annual and lifetime limit n mney raised: The cmpany may nt raise mre than 5 millin in any 12-mnth perid frm risk capital investments, which includes the venture capital schemes (SEIS, EIS, SITR and venture capital trusts) and any ther surce which cunts as aid under the EU guidelines n risk capital investments in SMEs. In additin, there is a lifetime limit f 12 millin fr such investments in any cmpany (r 20 millin fr knwledge-intensive cmpanies). In assessing bth limits, accunt must be taken f mney raised by subsidiaries, partnerships f which the cmpany r its subsidiaries are members and businesses acquired by the cmpany and its subsidiaries. Business f cmpany: The cmpany may be either: a slitary cmpany which exists whlly fr the purpse f carrying n qualifying trade(s); r the parent cmpany f a trading grup. Fr this purpse, a trade is a qualifying trade prvided that: a) it is carried n in a cmmercial manner; b) it des nt include t a substantial extent any excluded trading activity including: dealing in land, shares r financial instruments prviding finance r insurance leasing r receiving ryalties r licence fees certain prperty-based trades such as prperty develpment, farming, market gardening, htel management and perating r managing nursing hmes r residential care hmes subsidised generatin r exprt f electricity. In this cntext substantial is taken t mean 20 per cent but this culd be measured in a number f ways; c) the cmpany carrying n the trade has a permanent establishment in the UK _1 2

3 A cmpany is a parent cmpany f a trading grup if: all its subsidiaries are qualifying subsidiaries (see belw); and when the activities f the cmpany and its subsidiaries are taken tgether and assessed as a whle, these d nt include t a substantial extent either any excluded trading activity and/r any nn-trading activity (eg investment activity r nn-cmmercial activity). Grss assets: The grss assets f the cmpany (r the grup if applicable) must nt be mre than 15 millin befre the issue f EIS shares and nt mre than 16 millin immediately afterwards. Independence: The cmpany must be independent: it must nt be a 51per cent r mre subsidiary f anther cmpany; r under the cntrl f anther cmpany (r anther cmpany and a persn cnnected with that ther cmpany). Qualifying subsidiaries: Any cmpany under the cntrl f the cmpany seeking EIS funds must be a qualifying subsidiary, that is, a bna fide subsidiary. Fr this purpse cntrl includes a right t mre than 50 per cent f (a) the vting rights r (b) incme f a cmpany r (c) mre than 50 per cent f the assets f a cmpany n its winding up. Financial Health: Enterprises which, under EU guidelines, are in financial difficulty are nt eligible. Maximum Age: First EIS investments must nt be made in a cmpany which is mre than 7 years ld (10 years ld fr a knwledge-intensive cmpany). This age limit is calculated by reference t the date f the first cmmercial sale by the cmpany. This age limit is waived where the relevant qualifying investments exceed 50 per cent f the cmpany s (r grup s) average annual turnver and are t be used t enter a new prduct r gegraphical market. The shares The shares issued must be rdinary shares and (with certain exceptins) nt carry any present r future preferential rights t dividends, t the cmpany s assets n a winding-up, r t be redeemed. Subscriptin must be in cash and the shares must be fully paid up at the date f issue. In additin, n arrangements fr an exit rute fr the investr may exist. Use f funds The shares must be issued t raise funds fr the grwth and develpment f a qualifying business activity which will be undertaken by the cmpany r a 90 per cent subsidiary. The use f the mney fr the acquisitin f a cmpany r a business, gdwill r certain intellectual prperty is specifically prhibited. Existing sharehldings If an individual subscribes fr shares in a cmpany and that individual already hlds shares in that cmpany (r a subsidiary), the new shares will nt be eligible fr EIS unless the existing shares are subscriber shares r were issued under the SEIS, EIS r SITR schemes. The investr The investr must be an individual (althugh investment via a nminee is pssible). He/she must nt be cnnected with the EIS cmpany at any time during the perid cmmencing tw years prir t the issue f the EIS shares and ending n the relevant third anniversary. There are different types f cnnectins: Investr cnnectins: An individual is cnnected with a cmpany if he directly r indirectly wns ver 30% f: the issued rdinary share capital f the cmpany r any subsidiary; _1 3

4 the lan capital and issued share capital f the cmpany r any subsidiary; r the vting pwer in the cmpany r any subsidiary. Fr this purpse, an individual is treated as wning any asset which he is entitled t acquire (eg n exercise f an ptin) and which any f his assciates wns r is entitled t acquire. Wrk cnnectins: An individual is cnnected with a cmpany if he r any f his assciates is an emplyee r directr f the cmpany r any subsidiary (unless the business angel exceptin applies (see belw)) r a partner in a business partnership with the cmpany r any subsidiary. Business cnnectins: An investr is cnnected with a cmpany if he was at any time invlved in carrying n the trade carried n by that cmpany r a subsidiary whether as a sle trader, partner, directr r emplyee. Business angels There are special rules fr business angel investrs. In general, a business angel is smene wh has nt previusly been cnnected with the EIS cmpany and nly becmes a directr f the cmpany when the EIS shares are issued and is thereafter entitled t receive nly reasnable remuneratin fr services prvided t the EIS cmpany. Occasinally, smene wh is an unpaid directr befre making an investment might be eligible fr business angel status but this will depend n all the circumstances. Business angels seeking EIS relief are, in particular, recmmended t seek prfessinal advice n their eligibility r therwise fr EIS relief. If the investr is cnnected with the EIS cmpany, mst EIS reliefs will be unavailable but capital gains tax deferral relief wuld still be available prvided that the ther cnditins are met. Lan-linked investments EIS relief will nt be available if the investr receives a lan which wuld nt have been advanced t him (r nt n the same terms) but fr his investment (r intended investment) in the shares issued by the EIS cmpany. Withdrawal f relief Breach f EIS cnditins If the cmpany, the shares r the investr fails t meet the required cnditins relief will be withdrawn. Incme tax relief and capital gains tax exemptin: withdrawn if any f the abve cnditins cease t be met befre the relevant third anniversary. Capital gains tax deferral relief: withdrawn n the ccurrence f a chargeable event. Chargeable events include: the dispsal f the shares (ther than t a spuse r civil partner) at any time; the investr becming nn-resident; the cmpany lsing qualifying cmpany status befre the relevant third anniversary; the investr receiving value frm the cmpany; r the cmpany buying in shares frm any sharehlder in the year prir t the investment r befre the relevant third anniversary). Lss relief: will cease t be available if at any time while the shares are held, any f the cnditins which the cmpany must fulfil fr EIS relief cease t be met. Receipt f value frm the EIS cmpany If the investr r an assciate receives value frm the EIS cmpany (r a cnnected cmpany) then relief is reduced accrdingly r, in the case f deferral relief, withdrawn. Detailed prvisins utline the circumstances in which receipt f value ccurs (including any repurchase f shares by the EIS cmpany, nn-arm s length remuneratin t the investr fr services, r the transfer f an asset t the investr at an undervalue). Receipts f insignificant value are ignred where the ttal f all such receipts by the investr is less than 1,000 as are certain _1 4

5 qualifying payments. It is imprtant t nte that the receipt f value rules als apply where value has been received in the year prir t the EIS investment. Mills & Reeve can advise yu n all aspects f the Enterprise Investment Scheme. Please cntact: Christpher Twnsend Partner +44(0) christpher.twnsend@mills-reeve.cm Kevin Lwe Partner +44(0) kevin.lwe@mills-reeve.cm Debrah Clark Head f Private Tax & Trusts +44(0) debrah.clark@mills-reeve.cm T +44(0) Mills & Reeve LLP is a limited liability partnership authrised and regulated by the Slicitrs Regulatin Authrity and registered in England and Wales with registered number OC Its registered ffice is at Mnument Place, 24 Mnument St, Lndn EC3R 8AJ, which is the Lndn ffice f Mills & Reeve LLP. A list f members may be inspected at any f the LLP's ffices. The term "partner" is used t refer t a member f Mills & Reeve LLP. The cntents f this dcument are cpyright Mills & Reeve LLP. All rights reserved. This dcument cntains general advice and cmments nly and therefre specific legal advice shuld be taken befre reliance is placed upn it in any particular circumstances. Where hyperlinks are prvided t third party websites, Mills & Reeve LLP is nt respnsible fr the cntent f such sites _1 5