Enterprise Investment Scheme
The Enterprise Investment Scheme offers generous income tax and capital gains tax reliefs to investors in certain companies.
The reliefs are available to ‘qualifying individuals’ who subscribe for ‘eligible shares’ in ‘qualifying companies’ undertaking ‘a qualifying business activity’. The regime is currently under review, but the consultation is ongoing.
What are the investment limits?
Individuals may invest any amount in Enterprise Investment Scheme shares. However, only the first £400,000 invested in any one tax year (£200,000 prior to the tax year 2006/07) will qualify for income tax relief and capital gains tax (CGT) exemption. For this purpose a husband and wife are treated separately. Individuals must subscribe a minimum of £500 in any one tax year. Several subscriptions can be combined to meet these limits. It was announced in the Budget 2008 that the investment limit for claming Enterprise Investment Scheme income tax relief would be raised to £500,000. This will come into force when State Aid approval has been received but will have effect from 6 April 2008.
Who are ‘qualifying individuals’?
This is any individual who has subscribed for shares wholly in cash in the company unless they are connected with that company. The connection can be by way of employment, partnership, or by being an associate (eg a spouse or child; but not a brother or sister) of such a person. The individual will also be connected if he/she owns or is entitled to acquire, directly or indirectly, more than 30% of the issued ordinary share capital, loan capital, issued share capital or voting power of the company or a subsidiary. They must also be a qualifying individual for the two years prior to the share issue and three years after the share issue date or the date on which trading commences, if later.
These connection conditions do not apply to the CGT deferral mentioned below.
What are ‘eligible shares’?
Eligible shares are any new ordinary shares issued in the Enterprise Investment Scheme company for bona fide commercial reasons, which, throughout the period of three years beginning with the date on which they are issued, carry no preferential rights to dividends or assets on liquidation of the company. The shares must be fully paid up at the time of issue and they cannot be redeemable.
What are ‘qualifying companies’?
A qualifying company need not be resident in the UK for tax purposes but it must be unquoted and the funds raised must be used by the issuing company or by a qualifying 90% subsidiary in carrying out qualifying activities. Where a parent company is raising funds, it must only have 51% subsidiaries to be a qualifying company, with the exception of property management subsidiaries which must be held 90%. However, the funds can only be used by qualifying 90% subsidiaries.
Companies listed on the Alternative Investment Market are treated as unquoted for the purpose of this relief. The gross assets of a nongroup company, or aggregate gross assets of the group, must not exceed £7m prior to investment nor £8m post investment (£15m and £16m respectively for shares subscribed for before 22 March 2006 or issued before 6 April 2006).
As from 19 July 2007, qualifying companies must have fewer than 50 employees and cannot have raised more than £2 million from Venture Capital Trusts, the EIS or the Corporate Venturing Scheme in the last year. However shares issued to Venture Capital Trusts on or before 5 April 2007, shares issued to Venture Capital Trusts for money raised on or before 5 April 2007 and shares issued under the Corporate Venturing Scheme and EIS prior to 19 July 2007 are ignored for these purposes).
What is a ‘qualifying business activity’?
Broadly speaking, the business activity for which the money is being raised should be conducting a qualifying trade wholly or mainly in the UK during the three years from when the shares are issued or, if later, three years from when the company commences to trade. Research and development undertaken with the intention of starting a trade is also treated as a qualifying business activity.
Qualifying trades encompass all forms of trading except for certain prohibited businesses including dealing in land, financial activities, legal/accountancy services and property backed activities. It was announced in the Budget 2008 that this list would be extended to include the activities of shipbuilding and coal and steel production.
What are the tax benefits of an EIS investment?
20% income tax relief
This relief takes the form of a credit against an individual’s personal tax liability. It is given at 20% of the sum invested subject to there being sufficient tax liability to absorb the relief. Thus the maximum tax credit available to an individual is £80,000 in each tax year (£100,000 when the investment limit is increased to £500,000).
For shares issued between 6 April and 5 October up to half of the investment, subject to an overall maximum of £50,000 (£25,000 prior to 6 April 2006), can be treated as being made in the previous tax year. Other reliefs are as set out overleaf..
No capital gains tax on disposal
If a qualifying individual holds eligible shares for more than three years from the date of issue (or from the date of commencement of trading, if later), then any capital gain on the disposal of the EIS shares after that period will be tax–free, subject to any withdrawal of the relief as mentioned below.
Further, if a loss arises on the disposal of EIS shares then, subject to adjusting for the income tax relief previously claimed, that loss will be available to the investor. This relief can either be claimed as a capital loss or as a loss for income tax purposes.
Deferral of tax on other capital gains
CGT on a gain from the disposal of any asset can be deferred against an EIS share subscription. The tax on any gain rolled over in this way only becomes due on disposal of the EIS shares or if the individual ceases to be UK resident within 3 years of issue of the shares. There is no requirement to obtain income tax relief to qualify for capital gains tax deferral and the amount of the gain which can be deferred is unlimited. To qualify for deferral relief the investment must be made during the period one year before the realisation of the gain to three years after.
Where a deferred gain becomes chargeable on the disposal of EIS shares, it will be subject to the CGT rate in force at that time (and not at the time the original disposal was made). Therefore, even if the original disposal would have qualified for taper relief, it will not do so after 5 April 2008 (the date taper relief was abolished), and will be subject to the flat rate of 18%.
However, a new form of relief (entrepreneurs’ relief) may be available for disposals after 5 April 2008 where the relevant conditions are satisfied. In some circumstances this could reduce the effective rate on disposal to 10%.
Are there any further requirements?
Yes, the money raised by the issue of EIS shares must be wholly applied in qualifying business activities. The funds must be applied within 12 months of the share issue, or where it is a new trade, within 12 months of the start date.
What if I sell the shares early?
A disposal of EIS shares within three years of issue could have three effects:
- There may be a restriction of the EIS reliefs previously given and, if so, the relief will be clawed back
- Any capital loss arising can be set against income for the same or the preceding tax year or against capital gains in the same or subsequent tax years
- The CGT exemption will be lost.
Can the tax relief be taken away?
Yes. The main conditions for retaining relief are:
- The company must not cease to be a qualifying company during the three year period from the date of issue of the shares or the start of trading, if later
- There must be no arrangements at the beginning of the relevant period for the company to become quoted during the three year period
- Shares must be fully paid up when issued
- The company must not be controlled by another company or companies, although for shares issued on or after 21 March 2000 this should not prevent financial institutions having a stake in the form of preference shares as the test is based on the number of shares or voting power. This restriction applies to any arrangements for another company to acquire control at some time in the future (such as share options)
- If the individual investor becomes connected with the company during the relevant period, relief is withdrawn
- Problems may arise and cause a restriction or withdrawal of the EIS relief if companies redeem or repurchase non-EIS shares during the period commencing two years before and ending three years after an EIS issue
- Investors who receive any value from the company within a period commencing two years prior to the issue of the EIS shares and three years after may find their relief being adjusted or withdrawn. This restriction does not apply to normal salaries for new directors, nor does it apply to interest given at a commercial rate on monies lent by the investor, dividends representing a normal return on investment or other normal commercial arrangements between the investor and the company
Can I oversee my investment?
Yes! To a certain extent. The EIS rules allow investors to become directors of companies into which they have invested as long as they become directors after the issue of the shares. Such a position may be executive in nature and the individual may be remunerated accordingly.
Who should I contact?
This article has dealt with some of the rules and regulations for EIS relief and broadly outlines the scheme. Investment in the Enterprise Investment Scheme is high risk and both investors and issuers should seek professional advice before undertaking such investments. If you need guidance on this subject or other matters please contact your Independent Financial Advisor or Find an IFA.