EIS: An Overview
EIS stands for Enterprise Investment Scheme, a scheme which gives tax reliefs to individual investors in return for investment in small and early stage private companies. If your start-up or early stage business is looking for investment from individuals, being EIS-compliant can help attract funding as it is a very tax-efficient way for them to invest.
What is EIS and why should it interest you?
Relief 1: Income Tax
Provided that the investor holds qualifying shares for three years, the investor’s income tax liability is reduced by 30% of the sums invested, up to the annual investment limit (currently £1,000,000). The relief is available for the tax year in which the shares are issued, but the investor may elect to treat the shares as having been issued in the previous tax year. By way of example, in the 2015 - 2016 tax year, Adam invests £250,000 by way of subscription for new ordinary shares in a qualifying company. Adam’s income tax liability for 2015 - 2016 is reduced by £75,000 (30% of £250,000).
Relief 2: Capital Gains Tax
Provided that the investor holds qualifying shares for three years, the investor is exempt from any liability to pay capital gains tax on a disposal of the qualifying shares.
Genuine: The subscription must be made for genuine commercial reasons and not for tax avoidance purposes.
Time period for holding shares: To retain income tax relief and capital gains tax exemption, the shares must be held for at least three years.
Cannot be connected: Neither the investor nor an associate of the investor must be connected with the issuing company. This means that:
- they cannot be an employee or director of the issuing company, any subsidiary or any partner of them (although note, there are certain exemptions for unpaid directors);
- they cannot be a partner of the issuing company or subsidiary;
- they cannot hold a material stake (i.e. their shareholding must be under 30% of the ordinary share capital, 30% of the issued capital or 30% of the voting rights) in the company or any subsidiary or
- otherwise control either of them (and note that holdings of shareholders who are related or partners in a partnership are aggregated when considering whether the threshold of 30%); and
- their share subscription must not be as a result of a reciprocal arrangement.
Conditions: Issuing Company
Unquoted: The issuing company must be unquoted at the time the shares are issued and there must not be any arrangements for it to become quoted.
Independence: From the date of issue of shares and for a period of three years post-issue, the issuing company must not be under the control of another company or a 51% subsidiary of another company.
Gross Assets Test: The value of the issuing company’s gross assets must not exceed £15 million immediately before the shares are issued and £16 million immediately afterwards.
Qualifying Trade: The issuing company must carry on a qualifying trade from the issue of shares and for a period of three years post-issue. The tax reliefs will be withdrawn if this condition ceases to be met at any time in the three years post-issue.
Permanent UK Establishment: The issuing company must have a permanent establishment in the UK from the date of issue and for a period of three years post-issue.
Employees: The issuing company must have fewer than 250 full-time employees or part-time equivalents. If the issuing company is a parent company of a trading company, the 250 limit applies to the issuing company and trading company in aggregate.
Financial Limits: The issuing company cannot raise more than £5 million by way of relevant investments in the year preceding the issue of EIS shares and no more than £12 million (£20 million if the issuing company is a knowledge-intensive company) in total investments. Relevant investments are investments under the EIS, SEIS (seed enterprise investment scheme) and SITR (social investment tax relief) together with any investment by a VCT (venture capital trust) and any other scheme that qualifies as state aid. Furthermore, if either condition A or condition B applies, the issuing company must not raise more than £12 million (£20 million for knowledge-intensive companies) in relevant investments during the period from the date of issue up to three years post-issue:
- Condition A: Some money raised from the share issue is employed in the trade of a 51% subsidiary acquired in such period and that subsidiary previously carried on that trade.
- Condition B: Some money raised from the share issue is employed in a trade (previously carried on by another person) acquired directly or indirectly by the issuing company in such period.
Time Period for Issuing Shares: Shares should be issued in the initial investing period, otherwise additional conditions apply. The initial investing period is seven years from the date of first commercial sale or, if the issuing company is a knowledge-intensive company at the issue date, ten years from the date of first commercial sale. First commercial sale is the issuing company’s first sale of a product or service. Limited sales to test the market are excluded.
Purpose: The shares must be issued in order to raise money for the purpose of a qualifying business activity and must be paid up in full at issue.
No Preferential Rights: The shares must be non-redeemable ordinary shares and must not carry any preferential right to dividends or assets on a winding up.
No Pre-Arragned Exits: The shares must not be issued under any agreement or arrangement in relation to an exit or to reduce the investment risk.
Advance Assurance: The issuing company can apply to the HMRC Small Company Enterprise Centre to obtain advance assurance. Whilst not strictly necessary to obtain advance assurance in order for the reliefs to be available, the assurance provides comfort to the issuing company that its proposed share issue satisfies the necessary criteria and, in turn, such comfort makes the issuing company attractive to investors.
Formal Approval and Issue of EIS Certificates: The issuing company will need to apply for formal approval by submitting form EIS 1 to the HMRC Small Company Enterprise Centre. The application must be submitted within two years after the later of (i) the end of the tax year in which the shares were issued, or (ii) four months after the issuing company has started to trade or the research and development for which the funds were raised has been carried on. Formal approval is given by HMRC on form EIS 2, which authorises the issuing company to issue compliance certificates, known as EIS 3. The issuing company is then required to issue the EIS 3 certificates to the investors so that they can make claims for relief in their self-assessment tax returns.
For further information about the EIS, you can contact Kirsty Simmonds or you can call us on 0345 070 6000.