Enterprise Investment Scheme (EIS) and Capital Gains Tax
Two cases have been considered recently by the First-tier Tribunal concerning CGT in relation to EIS investments. In Robert Ames v HMRC (TC04523) the tribunal had to consider whether a disposal of shares was chargeable to CGT where the shares would have qualified for EIS relief but the individual did not make a claim; in East Allenheads Estate Limited v HMRC (TC04513) the question was whether the company existed wholly for the purpose of carrying on a qualifying trade.
Robert Ames was a skydiver, and together with other individuals developed the idea of an indoor skydiving simulator. In June 2003, he asked HMRC to provide EIS advance assurance in respect of a company, Skyventure UK Limited.
Mr Ames subscribed for shares in the company, but his income for the year was fully covered by his personal allowance. He did not make a claim for EIS relief although the shares would have qualified as EIS shares.
He later sold the shares realising a large gain which he claimed was exempt from CGT under TCGA 1992, s 150A. However, HMRC argued that this exemption did not apply because in order to fall within the exemption an amount of EIS relief must be “attributable to the shares”.
The tribunal agreed with HMRC, taking the view that a claim for EIS income tax relief, however small, must be made in order to meet the requirement that relief is attributable to the shares. The ability to claim relief is not sufficient, and in Mr Ames’ case he should have claimed EIS relief even though it made no practical difference to his income tax position when he subscribed for the shares.
East Allenheads Estate Limited
The business of East Allenheads Estate Limited (“the Company”) was the running of a grouse shooting estate with high quality accommodation. The sole shareholder was Jeremy Herrmann, who subscribed £6.5m for shares in the company and claimed EIS deferral relief.
Mr Herrmann had acquired the estate about three years before the incorporation of the Company, having been advised that it would be appropriate to run the shoots through a corporate structure. The Company acquired the moor from Mr Herrmann, but he retained the hall which was used to provide accommodation for the Company’s customers. Mr Herrmann did not live at the hall.
The Company spent a large proportion of the £6.5m raised on improvements to the hall and on some expensive antiques, and in particular a Magritte painting costing £2.8m. The Company explained to the tribunal that this expenditure was incurred to attract the highest quality of client.
HMRC focussed on a number of issues which led them to conclude that EIS deferral relief was not available in respect of Mr Herrmann’s investment in the Company. The legal arrangements between the Company and Mr Herrmann in respect of the use of the hall were unclear, and his advisers gave conflicting explanations of the nature of those arrangements. HMRC appeared to take the view that the expenditure was essentially for the benefit of Mr Herrmann, as it enhanced the hall and enabled him to indulge his interest in shooting, and that the subscription was motivated by the wish to defer other capital gains over and above any commercial intent the Company might have, observing that the subscription was unusually large, and was made a matter of days before the investment limit was reduced to £2m.
The tribunal dismissed HMRC’s latter contentions, and focussed on whether the Company existed (ignoring any incidental purposes) for the purpose of carrying on its trade on a commercial basis and with a view to the realisation of profits. The tribunal found that the purposes of conferring personal benefits on Mr Herrmann and of making investments in valuable art and antiques could not be regarded as incidental. As a result, the requirements of paragraph 1(2)(b) of Schedule 5B are not met, so EIS deferral relief is not available.
The tribunal added that if this is incorrect, they concluded also that the Company did not raise the money for the purpose of carrying on its trade on a commercial basis and with a view to the realisation of profits – the company had made losses for a number of years (paragraph 1(2)(f)).
Furthermore, the tribunal concluded that the requirement that the Company must spend at least 80% of the money raised for the purpose of carrying on its trade within 12 months, and the balance of the money raised within a further 12 months for the same purpose will not be met if at least some of the money was not spent for such purposes (paragraph 1(2)(g) and (h)).
The Company’s appeal was, therefore, dismissed, and EIS deferral relief was held not to be available in respect of the share subscription.
What these cases mean for EIS investors
These cases demonstrate the complexity of the EIS legislation, and also that HMRC will look closely at claims in relation to the relief. Robert Ames shows that claimants must not overlook the finer points of the legislation. In particular, individuals who have invested in EIS shares must claim income tax relief even if it does not immediately benefit their tax position.
The case of East Allenheads Estate shows the importance of ensuring that the company carries on a qualifying activity and that it is not tainted by other activities. Furthermore, it demonstrates that HMRC will look closely at situations that fall outside their norms, where they feel that tax avoidance is the main motive – even when looking at a relief which is contained in legislation.
Extreme care must be exercised whenever dealing with EIS and SEIS relief.