September 18, 2020
For startups, raising money is key to ensuring they ‘kick start’ their business. Attracting potential investors to invest in what may prove to be a risky venture is challenging, which is why obtaining EIS and SEIS relief can be valuable.
EIS (or the Enterprise Investment Scheme) provides investors with up to 30% of their investment back in income tax relief (plus investors can defer up to 50% capital gains tax until after the EIS investment matures). Loss relief can also be set against investors’ capital gains tax or income tax in the year of disposal or the previous year.
SEIS (or the Seed Enterprise Investment Scheme), on the other hand, provides investors with income tax relief at a rate of 50% on the value of the investment (plus investors can also benefit from up to 50% capital gains tax relief up to a maximum of £50,000 on gains which are re-invested in EIS eligible shares). Any gain resulting from the disposal of the shares may also be exempt from capital gains tax if the shares are held for three years, and the loss relief is also accessible if the investment fails.
A company can raise up to £150,000 in total under SEIS and up to £5 million per year subject to a cap of £12 million under EIS (and any other venture capital schemes).
Because of the tax advantages to investors, a lot of companies seek to obtain advance assurance from HMRC to attract investors. However, the rules surrounding SEIS and EIS can be complicated to understand and therefore we’ve put together this blog to outline some of the most common mistakes made by companies when dealing with SEIS and EIS.
Although it’s possible for an investor to invest in the same company and claim both SEIS and EIS relief, SEIS funds must be raised first! If a company mistakenly issues an EIS compliance statement, it cannot withdraw, revoke or replace it and SEIS relief will be denied. It’s therefore important that the company ensures its admin is in order or instruct professionals to deal with it for them.
This means that an investor mustn’t be subscribing for shares in the company as part of an arrangement that includes another person subscribing for shares in the company in which the investor or related party has a substantial interest.
From the date of incorporation of the company to the date of the third anniversary of the date of the SEIS share issue, there mustn’t be any loans to the investor or their associates which are linked to their subscription for SEIS shares. A loan is ‘linked’ if it wouldn't have been made but for the relevant subscription.
For SEIS and EIS reliefs, investors can’t hold a stake in the company (or any subsidiary) at any time in the period beginning with the date of incorporation of the issuing company and ending on the third anniversary of the SEIS shares, which exceeds 30% of the issued share capital, ordinary share capital or voting rights, or which would entitle the investor to more than 30% of the assets of the company (or subsidiary) in the event of a winding up or in any other circumstances.
For SEIS, an investor (or any associate) mustn’t be an employee of the issuing company (or any subsidiary), at any time during the period from when the shares are issued to the third anniversary of issue. An investor (or associate) may, however, be a director (paid or unpaid).
For EIS, an investor mustn’t be connected with the company at any point beginning two years before the issue of the shares and ending immediately before the third anniversary of the issue date. An individual will be ‘connected’ if they’re an employee, a director, hold a material stake or subscribe for shares under reciprocal arrangements. However, it's important to note that unpaid directors aren't treated as connected with the company. Paid directors also aren’t treated as connected with the company if the following conditions are met:
In addition, under SEIS, a company must have fewer than 25 employees when the investment is made and under EIS, a company must have less than 250 employees when the investment is made (which increases to 500 employees if the company is ‘knowledge-intensive company’).
According to HMRC, this is the most common failure by companies. The shares must be fully paid up in cash when they are issued. Accordingly, shares must not be issued at a time when the company hasn't received payment for them in full. An agreement or ‘undertaking’ to pay at a future date isn't sufficient.
Shares must be full-risk ordinary shares and mustn't be redeemable or carry preferential rights to a company’s assets on a winding-up, even a very small preference will infringe this requirement, even if it is unintentional. Further, the shares mustn’t carry preferential rights to dividends if the right depends (to any extent) on a decision of the company, a shareholder or any other person, or where the right to receive a dividend is cumulative. Care must be taken when drafting the articles of association and any shareholders’ agreement, and professional advice should be taken.
For SEIS purposes, a company carries on new and ‘qualifying trade’ if both the following conditions are met:
An Advance Subscription Agreement (ASA) is an agreement under which an investor agrees to pre-pay for shares that are guaranteed to be issued to them in certain circumstances.
HMRC has updated its guidance to address the extent to which ASAs qualify under S/EIS schemes. The more complex the agreement and the longer the gap between the investor entering the agreement and shares being issued, the less likely it is that the arrangements will satisfy the requirements of the legislation. HMRC has confirmed that for monies paid under an ASA to be eligible for S/EIS:
Applications for advance assurance should be made before any ASA is entered into and the relief will only be available from the date of issue of the shares.
Should you require further information or help with SEIS/EIS advance assurance applications, please do not hesitate to contact us.