For many businesses, raising finance to ‘kick start’ new trading activities is key. Attracting investors to part with their funds to invest in what may be a risky venture can be challenging and that is why reliefs such as the Enterprise Investment relief (‘EIS’) and Seed EIS (‘SEIS’) can become very valuable. EIS is long established but SEIS was specifically introduced in 2012 in order to incentivise smaller start-up businesses aimed at companies who wish to raise funds of up to £150,000.
Under both EIS and SEIS, investors in qualifying companies, which use the invested funds for a qualifying trade, can get immediate income tax relief of 30% and 50% respectively on money invested with capital gain exemption on sales of shares after three years (on the proviso the income tax relief was claimed and not withdrawn).
Like many valuable reliefs, there are conditions which have to be applied in order to secure them and it is fair to say that EIS and SEIS have more than their fair share of conditions which can create pitfalls for businesses seeking investment and their investors. Coupled with this, recent changes in legislation and cases before the courts seem to indicate that HMRC are taking a harder line on such claims for relief.
Before mentioning two recent cases demonstrating HMRC ‘s current approach, it is worth highlighting some common potential pitfalls which, with some careful consideration at the outset, can be avoided, ensuring that relief is not lost.
- An investor should not be connected with the company two years before and three years after the issue of the shares. Connection for these purposes is more than 30% of the ordinary share capital, voting rights and assets on a winding up of the company. In this regard, the timing of the issue of shares is crucial and there may be a need for investors to invest simultaneously to prevent this condition from being breached;
- The shares must be fully paid up at the time they are issued and be subscribed for wholly for cash. It is important that the investor’s name is entered into the register of members. Issuing shares before funds have been paid because of delays in setting up a bank account will prevent relief from being claimed. Conversely, making an investment up front without shares being issued could be treated as a loan satisfied by the later issue of shares. Again relief will be denied. To prevent this, subscription money should be paid into a newly set up company bank account and shares issued immediately;
- The money raised must be used, within given timescales, for the purposes of the qualifying business activity. Using the funds to repay loans or to acquire interests in other companies or trade and assets would not meet this test and prevent relief being available. A detailed business plan with clear use of the funds is necessary and it is usually advisable that the money is not spent by the company before shares are issued and should be ring-fenced to demonstrate its use;
- The shares must not carry any preferential rights. Care should be taken for example where other non-EIS/SEIS shares are issued with restricted rights automatically conveying preferential rights on the EIS/SEIS shares. Such aspects need to be considered when implementing employee share schemes or putting together a shareholders’ agreement;
- The trade, in respect of which money has been raised, must be a qualifying trade conducted on a commercial basis and with a view to profit. It must not involve to a substantial extent the carrying on of excluded activities, a list of which can be found at https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm3010 This condition must be met throughout the three year period the shares are held.
Where companies seek assurance that any investment in them will qualify for relief, ‘advance assurance’ from HMRC can be sought. However, HMRC will not provide advance assurance on speculative applications. They would expect companies making applications to have formalised offers of investment identifying the names of investors and the amounts they expect to invest.
In two recent cases HMRC has sought to challenge the capital gains tax (‘CGT’) reliefs associated with EIS/SEIS investments.
In Robert Ames v The Commissioners for HMRC , HMRC denied CGT relief because no claim for income tax relief had been made by Robert Ames, the reason being that his income for the year was only £42.
Robert had subsequently made a late claim for income tax relief but was turned down by HMRC despite HMRC’s care and management powers, under s 5(1) of the Commissioners for Revenue and Customs Act 2005, to allow claims in exceptional cases.
The Upper Tribunal has since allowed the case to be taken forward for judicial review with an order for HMRC to remake their decision so the signs are positive that the late claim would be accepted and CGT relief allowed.
In the second case of Oxbotica Ltd  the company sought authority to issue SEIS certificates for investments made by three individuals subscribing £316 in total for shares.
There is no minimum figure on which relief can be claimed under SEIS nevertheless, because the investment made by the individuals was small and the company had already secured funding from other sources, HMRC did not accept that the investment was provided for the purposes of the activity but instead to secure CGT relief on a future sale of shares.
The First-tier Tribunal rejected HMRC arguments stating that despite the small investment it had been made for the purpose of and in fact spent in the conduct of the qualifying activity. Relief was therefore due.
Although it would appear that both cases will be won by the taxpayers, it is disappointing that both, which involve genuine investments to support start-up businesses have ended up in the courts. Given recent changes to legislation which provide that investments must be made to grow and develop the business it is debatable whether HMRC would have a better chance of winning the argument in Oxbotica if replicated for share issues today. The availability of the reliefs continues to a complex area and it is important that practitioners and clients exercise great care when putting EIS/SEIS applications together, follow the right sequence of steps and seek advance assurance at the appropriate time.
For further information and help with EIS/SEIS advance assurances and applications, please contact Gabelle on 0845 4900 509 and ask for Martin Mann or Paul Howard.