Enterprise Investment Scheme (EIS) is designed to provide investors with tax relief on their investments. Offering EIS can be a great incentive to attract new investors to your company. Tax Reliefs on Offer
EIS offers five different types of tax relief associated with capital gains tax, income tax, inheritance tax, capital gains tax deferral relief, and loss relief.
How Can Investors Qualify?
- There will be no capital gains tax liability for gains if the shares are held for the specified qualifying period.
- Individuals who invest in shares from an EIS qualifying company will receive income tax relief, at a rate of 30% the cost of the share (valued at or less than to £1 Million as of 5 April 2012). This relief can be applied to shares purchased in the current tax year, or it can be set back to the previous tax year, but it cannot be carried to future years.
- Because of interactions with Business Property Relief, investors who hold shares from a qualifying EIS company may be exempt from inheritance tax liability after two years.
- When investors reinvest capital gains in a qualifying EIS company, their capital gains tax payable may be deferred. This deferral is applicable within 1 year before the capital gain or 3 years after the capital gain was incurred. With this relief, the capital gain does not have to meet a minimum or maximum value or fulfil a holding period. It also does not matter if the company and the investor are connected.
- If the investor’s share are disposed of at a loss, they can choose to set the loss (minus any previously claimed income tax relief) against other annual income rather than having it set against capital gains.
In order to qualify the shares allocated to the investor should be paid in full in cash upon the issue and it must be an ordinary “full risk” share with no unusual security, such as privileged rights to dividend or rights to the company’s assets in the event of a loss. The investor cannot qualify for any tax relief if they receive special security from the company upon acquisition of the share; such as in the form of a protection arrangement for the investor intended to minimise their risk during or after the qualifying period. Investors should bear in mind that reliefs are only available for the issue of new shares. In addition, the following stipulations must apply:
- The shares must be allocated for genuine trade reasons, not tax avoidance.
- The investor must own the share for at least three years from the time that it was issued or from the date that the qualifying trade began (if the qualifying trade period began after the issue of the share).
- The investor must not be connected to the company in order to qualify for capital gains tax relief and income tax relief. An individual is considered to be connected to the company if:
- Within the two years prior to the allocation of the share or three years after the allocation of the share, the individual served as the company director (unless they fall under the “business angle exemption” outlined below) or one of the company’s employees. There is an exemption, however, for company directors that have not received, and are not entitled to, remuneration for the position.
- The individual owns more than 30% of the capital shares of the company (either independently or jointly with associates), they hold more than 30% of the company’s voting rights, or they are entitled to more than 30% of the company’s assets in the event of a winding up.
Investors who successively become company directors may fall under the “business angle exemption” if:
How Can the Company Qualify?
- At the time that the shares were issued, the investor had no connection to the company
- The investor had no previous connection to the company’s trade
- The investor is receiving a reasonable director’s salary
In order to qualify for EIS, the company must fulfil the following criteria:
- The company cannot be traded on any recognised stock exchange market, including the London Stock Exchange’s Main Market. Companies listed on AIM or PLUS may still qualify for EIS as these exchange markets are not officially recognised.
- The company must be autonomous, meaning it cannot be under the control of another company or have plans to fall under another company’s control in the future.
- The company must own at least 50% of each subsidiary it has (unless it is a property management subsidiary, in which case the company must own 90%).
- The company must be considered a “small company”—meaning that its gross assets are valued at less than £15 million pre-investments and £16 million post-investment for shares issued as of 6 April 2012.
- The company must be participating in a qualifying trade, or it must be the parent company of a qualifying trading group (and own 90% of the qualifying trade subsidiary).
- The company cannot incur profits of more than £5 million between the three venture capital schemes within a 12 month period (the schemes being EIS, Venture Capital Trusts, and Corporate Venturing Scheme). There is also a lifetime limit on venture capital scheme profits, which will limit most companies to £12 million.
- The trade that is benefiting from the raised funds must be conducted wholly or mainly in the UK. However, the upcoming Finance Act will likely change this restriction, mandating instead that companies are simply required to have a UK permanent address. While several different types of companies will qualify for this form of tax relief, certain companies may be excluded if more than 20% of their trading activities fall under “excluded activities” (see below for more details).
- Investment funds can be used research and development purposes relating to a project, but the project itself must be conducted within 2 years from the time that the shares are allocated.
- The company must subscribe for share for genuine corporate reasons, not tax avoidance.
Excluded activities include:
- Trading in land, commodities, or financial instruments (like shares or securities)
- Trading in goods that are not characterised as ordinary wholesale or retail distributions.
- Financial activities such as loaning, banking, insurance, higher-purchase financing, etc.
- Leasing assets on hire (except for certain charter ship activities)
- Incurring royalties or licence fees (except in the case of the exploitation of an immaterial asset that the company has created)
- Offering accountancy or legal services
- Farming or gardening
- Property development
- The production of steel or coal
- Forestry activities, including owning or management woodlands, or producing timber
- Hotel management or the management of comparable establishments
- Nursing home management or the management of residential care homes
- Offering service to a company that mostly deal in excluded trades when the company controlling that trade also manages the service company.
In order for the investors to benefit from the EIS tax reliefs, the company must meet the above qualifications on a regular basis during the three-year qualifying period.