Frequently Asked Questions (FAQS) The Enterprise Investment Scheme ( EIS ) Introduction

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1 1 Frequently Asked Questions (FAQS) The Enterprise Investment Scheme ( EIS ) Introduction These FAQs are a distillation of the commonly asked questions in relation to the EIS scheme. Please note, this is not our general guide on the EIS scheme. Such a note can be found here. These FAQs are intended to supplement that note and are not an alternative. Despite being a statutory relief, EIS is not a simple relief. It is quite the opposite and there are numerous conditions in relation to the investor, the shares issued and the investee company. These all must be met in order for an individual investor to claim EIS relief. In some cases these conditions can continue to apply after the issue of the relevant shares, with tax relief clawed back if they cease to be met. We recommend that before any share issue in which SEIS or EIS monies are to be raised, the issuing company seeks specific advice regarding the conditions for relief and gives consideration to seeking an advance assurance from HMRC. Despite this warning, SEIS is also a very attractive relief. This is both from the perspective of the Investor and the Investee. So it is well worth persevering with the detail!

2 2 FAQs Do the shares need to be fully paid up in cash at the time they are issued? Indeed they do. Shares must be fully paid up in cash and not issued in satisfaction of a debt due to the investor. In practice, this means that cash should be received by the Investee Company on or shortly before the shares are issued to the Investor. In some cases it may be possible for the company to take funds from investors earlier, but specific advice should be sought in such circumstances. Can EIS relief be obtained on a conversion of loans or similar securities into shares? No way Jose. Relief is only available where shares are subscribed for in cash. What are the requirements for the shares issued? Again, the shares must be subscribed for wholly in cash and, in reality, must be fully paid up at the time they are issued. They must be ordinary shares and should not carry either a present or future preferential right to dividends or to the company s assets on a winding up (and no present or future right to be redeemed). However, it is generally fine to include a preferential entitlement to proceeds of sale of the company.

3 3 An ordinary share is a share that forms part of a company s ordinary share capital. Ordinary share capital means all the issued share capital of a company by whatever name called other than capital the holders of which have a right to a dividend at a fixed rate but no other right to share in the profits. Can an investor benefit from anti-dilution protection against later funding rounds? Not really. Relief is not available where the terms of issue of shares include any protection against the ordinary risks of investment. Of course, such anti-dilution protection would fall in to this trap. Care must also be taken where investors are to be given warrants or other rights to subscribe for shares in a later funding round, particularly where the strike price is discounted. Specific advice should always be sought in this regard. Can EIS shares be converted into deferred shares? A key condition for relief is that shares must be held for a 3-year period following their issue. If the original shares issued to certain persons (for example, directors) are converted into deferred shares if, say, certain performance targets are not met, then it would need to be considered whether, on a conversion, the investors will be treated as disposing of their original shares. In many cases if the shares were re-characterised from being ordinary shares to worthless deferred shares, this could amount to a disposal for EIS purposes. On this basis, if the conversion took place within 3 years of the original shares being issued, relief may be wholly or partially withdrawn (depending on how many of the original shares have been converted to deferred shares).

4 4 In some cases, however, there may be no withdrawal of relief, if for example the investor acts at arm s length and receives no value in exchange for the deferral of their shares. In such situations, the position would need to be carefully considered and we would generally recommend seeking an advance ruling from HMRC s Small Companies Enterprise Centre. Can EIS relief be obtained through an investment in an overseas company? The issuing company does not need to be incorporated in the UK but it must have a UK permanent establishment (PE). Broadly, a company will have a UK PE if: it has a fixed place of business in the UK through which the business of the company is wholly or partly carried on; or an agent acting on behalf of the company has and habitually exercises in the UK authority to enter into contracts on behalf of the company. The funds raised must be used for the purposes of a qualifying business activity which includes: carrying on a new qualifying trade; preparing to carry on a new qualifying trade which the company begins to carry on within two years after the issue of the shares; or carrying on research and development, which must either be carried on when the shares are issued or be commenced immediately afterwards, and which the company intends should benefit or lead to a new qualifying trade. The qualifying business activity may be carried on either by the company issuing the shares or by a company which is a qualifying 90 per cent subsidiary of that company. The funds may be used by the overseas company itself, provided the UK PE criteria

5 5 is met and the funds are used for a qualifying business activity. There is no stipulation that the funds must be spent in the UK. If a company incorporated in the UK receives EIS investment, can the funds raised be used by an overseas subsidiary? The funds may be used by an overseas subsidiary, provided that they are used for a qualifying business activity and provided the subsidiary is a qualifying 90% subsidiary. However, the company actually issuing the shares must still meet the UK PE requirement Can some of the funds raised through EIS be used other than for a qualifying business activity? An individual is only eligible for relief if the money raised by the issue of the shares is employed within a certain time and wholly for the purpose of the qualifying business activity for which it was raised. However, if an insignificant part of the money is employed for some other purpose, this is ignored. Are there other ways for an investor to make an EIS investment? Individuals can invest in qualifying companies directly or through a nominee or a suitable investment fund. Given the difficulties investors may have in identifying suitable companies in which to invest and the inherent risks arising from investing in smaller trading companies, some investors may wish to make investments through a fund (which can either be

6 6 approved or unapproved by HMRC). EIS funds are structured with a fund manager and a nominee company or custodian holding the shares in investee companies on behalf of the individual investors, thereby enabling investors to claim tax relief but with the benefit of having access to a managed portfolio of investments. Whilst EIS funds have become increasingly popular, specific SEIS funds have yet to gain traction. However, hybrid EIS funds have gained in popularity which can offer investors access to both schemes. Can a company issue EIS qualifying shares after SEIS qualifying shares have been issued? The issuing company is limited to raising a maximum of 150,000 through SEIS investment in its lifetime. The issuing company is however then able to seek EIS (or VCT investment) but only if at least 70 per cent of all monies raised under SEIS (at any time) have been spent in the company s qualifying business activities. If a company is seeking to raise in excess of 150,000 through the tax advantaged venture capital schemes, it must complete the SEIS qualifying share issue and spend at least 70 per cent of the monies (and be able to demonstrate this) before issuing any shares under EIS or VCT. The following question expands on this. What happens if a company wants to raise more than 150,000 and investors expect to benefit from both SEIS and EIS relief? EIS shares cannot be issued until at least 70% of any SEIS monies raised have been spent by the company in its qualifying business. However, HMRC accept in their published guidance that a company is not precluded from raising over 150,000 in one exercise and issuing shares under EIS in respect of the excess over 150,000 at a later stage.

7 7 It is, however, important to ensure that no debt is created between the company and the investor(s) in respect of the excess, so (for example) there should be no right for the investors to require repayment of the excess pending issue of the EIS shares. In such situations, we would recommend specific advice be sought and we would generally recommend seeking an advance ruling from HMRC s Small Companies Enterprise Centre.