The VCT and EIS regimes encourage investment in unquoted trading companies by offering generous tax reliefs to investors.

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1 briefing January 2017 VCT and EIS Qualifying Investments Is yur cmpany lking t raise investment frm venture capital trusts (VCTs) r frm individuals seeking tax relief under the enterprise investment scheme (EIS)? If it is, yu need t read this nte because it will give yu an verview f the key cnditins that must be met in rder t attract that investment. A bit f backgrund The VCT and EIS regimes encurage investment in unquted trading cmpanies by ffering generus tax reliefs t investrs. Under EIS, individuals (the EIS Investrs ) invest directly int unquted trading cmpanies fr rdinary shares. They enjy upfrnt incme tax relief n their investment, as well as tax free gains n sale f the shares. Under the VCT rules, individuals invest in shares in a quted cmpany (the VCT). The VCT then invests that mney int unquted trading cmpanies by way f shares and (in sme cases) debt. Again, the VCT investrs enjy upfrnt incme tax relief n their investment int the VCT, and tax free gains n sale f thse VCT shares, as well as tax free dividends. But all tax-breaks cme with strings attached. EIS Investrs and VCTs can nly invest in cmpanies that meet a lengthy list f cnditins. And any individual lking t claim EIS relief n an investment must als meet certain criteria. S in this nte we aim t give yu an understanding f thse key cnditins and criteria. Please bear in mind that this is a cmplex area f law, s what yu re abut t read is a summary nly. This nte is based n law and practice as at 3 January Except where stated the fllwing cnditins are cmmn t bth VCT and EIS schemes. Cnditins fr the Cmpany First f all, let s lk at the cnditins the cmpany must meet in rder t qualify fr investment by VCTs r by EIS Investrs: Unquted status: The cmpany must be unquted at the time f the investment with n arrangements in existence fr its fltatin. A cmpany whse shares are traded n AIM is treated as unquted _1 1

2 Number f emplyees: The cmpany (r grup) must have fewer than 250 full time emplyees (r their equivalents) at the time f the investment, 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% f the cmpany s perating csts in at least ne f the previus three years, r at least 10% in each f the previus 3 years (the 3 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% 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 VCTs) and any ther surce which cunts as aid under the EU guidelines n risk finance 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. Maximum age: EIS r VCT investments must nt be made in a cmpany which made its first cmmercial sale mre than 7 years befre the date the investment is made (r 10 years fr a knwledge-intensive cmpany). This age limit is waived where the aggregate amunt t be invested by VCTs and EIS Investrs exceeds 50% f the cmpany s (r grup s) annual turnver averaged ver the last 5 years, and all VCT and EIS mnies are t be used t enter a new prduct market r a new gegraphical market. The age limit is als waived if the cmpany raising the investment had previusly received state aid funding (including VCT r EIS investment) within 7 years f the date the first cmmercial sale was made and sme r all f the new investment is t be emplyed fr similar purpses. Grss assets: The grss assets f the cmpany (r the grup if applicable) must nt be mre than 15 millin immediately befre the investment is made, and nt mre than 16 millin immediately afterwards. Independence: The cmpany must nt be a 51% 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 raising the investment 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) the assets f a cmpany n its winding up. Financial Health: The cmpany must nt be in financial difficulty (under EU guidelines) when the investment is made. UK permanent establishment: The cmpany must have a permanent establishment in the UK. Business f cmpany: The cmpany must either exist whlly fr the purpse f carrying n qualifying trade(s), r be the parent cmpany f a trading grup. A trade is a qualifying trade if it is carried n in a cmmercial manner, and it des nt include t a substantial extent (bradly mre than 20%) any excluded activity _1 2

3 The list f excluded activities is t lng t reprduce here, but it includes: dealing in land, shares r financial instruments prviding finance r insurance leasing r receiving ryalties r license fees legal r accuntancy services certain prperty-based trades such as prperty develpment, farming, market gardening, htel management and perating r managing nursing hmes r residential care hmes the generatin r exprt f electricity r the generatin f heat r any ther frm f energy prducing gas r fuel. A cmpany is a parent cmpany f a trading grup if: all its subsidiaries are qualifying subsidiaries (see abve), and when 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 activity and/r any nn-trading activity (eg investment activity r nn-cmmercial activity). Cnditins fr the Investment Nw we ll lk at the cnditins that apply t the actual investment terms: EIS: The shares issued t EIS Investrs must be rdinary shares and must nt carry any present r future preferential rights t dividends (with certain exceptins), t the cmpany s assets n a winding-up, r t be redeemed. In additin, n arrangements fr an exit rute fr the investr may exist. VCT: At least 10% f a VCT s investment in a cmpany must be in eligible shares, which are shares with the same lack f preferential rights referred t abve. The remainder f a VCT s investment in a cmpany can cmprise any class f shares (even preference shares) r lans. Hwever, lans must nt be guaranteed (ther than by subsidiaries f the cmpany raising the investment), r repayable within 5 years (ther than in default situatins). Cnditins n the use f funds Next we turn t the restrictins n when and hw mnies invested by VCTs and by EIS Investrs must be used: Thse mnies must be: raised fr the grwth and develpment f a qualifying trade carried n either by the cmpany raising the investment r by a 90% subsidiary f that cmpany, and emplyed within tw years f the date the investment is made _1 3

4 Mnies raised frm VCTs r frm EIS Investrs cannt be used t fund (directly r indirectly) the acquisitin f a cmpany, a business, gdwill r certain intellectual prperty, cannt be used t refinance existing lans r liabilities, and cannt be emplyed n the acquisitin f any shares in ther cmpanies. Cnditins fr the investr (EIS nly) Finally, we ll summarise the key criteria that any individual investr must meet in rder t be able t claim EIS relief n an investment int an EIS-qualifying cmpany: First, the investr must be an individual (althugh investment via a nminee is pssible). Secndly, 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 all f thse existing shares either are subscriber shares issued when the relevant cmpany was first incrprated, r were issued under the SEIS, EIS r SITR schemes. Thirdly, the investr must nt be cnnected with the cmpany at any time during the perid cmmencing tw years prir t the issue f the shares and ending n the third anniversary. There are different types f cnnectins: Material interest cnnectins: An individual is cnnected with a cmpany if he r she has a material interest i.e. that individual directly r indirectly wns mre than 30% f: the issued rdinary share capital f the cmpany r any subsidiary; the 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 r share which he is entitled t acquire (e.g. n exercise f an ptin) and which any f his assciates wns r is entitled t acquire. Als, if any investr wuld, n a winding up (r any ther capital distributin) be entitled t receive mre than 30% f the assets available fr distributin t equity sharehlders f the cmpany r any subsidiary, that investr is treated as having a material interest and s is nt eligible t claim EIS relief. 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. 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 angels There are special rules fr business angel investrs. In general, a business angel is smene wh nt previusly been cnnected with the cmpany and nly becmes a directr f the cmpany when the shares are issued and is thereafter entitled t receive nly reasnable remuneratin fr services prvided t the cmpany. If the investr is cnnected with the cmpany, mst EIS reliefs will be unavailable but capital gains tax deferral relief wuld still be available prvided that the ther cnditins are met _1 4

5 As a general rule, the cnditins fr the capital gains tax deferral elements f EIS relief are nw much less stringent than fr the incme tax relief and capital gains exemptin elements, with several f the abve-mentined cnditins nt being relevant. Interested in knwing mre? At Mills & Reeve we have a great deal f experience advising cmpanies raising funding frm VCTs and EIS Investrs, and als in setting up and acting fr VCTs and EIS funds and investr grups. S if yu want t knw mre, we d lve t help - here s wh yu need t cntact: Neil Pearsn fr Mills & Reeve LLP +44(0) neil.pearsn@mills-reeve.cm Kevin Lwe fr Mills & Reeve LLP +44(0) kevin.lwe@mills-reeve.cm Christpher Twnsend fr Mills & Reeve LLP +44(0) christpher.twnsend@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. Mills & Reeve LLP will prcess yur persnal data fr its business and marketing activities fairly and lawfully in accrdance with prfessinal standards and the Data Prtectin Act If yu d nt wish t receive any marketing cmmunicatins frm Mills & Reeve LLP, please cntact Suzannah Armstrng n r suzannah.armstrng@mills-reeve.cm _1 5