A number of changes to EIS were announced in the July Budget. The stated aim of these measures is to ensure that the scheme is ‘well-targeted and in line with state aid rules’. According to the Tax Information and Impact Note issued when the changes were announced, these proposals are expected to generate additional tax revenues of £225m over the next 5 years. Therefore, it is clear that there will be more losers than winners from these measures.
Details of the specific proposals are set out below, but the headline points to be aware of are the following:
- A new category of company (a knowledge-intensive company (KIC)) has been defined. Some of the EIS conditions are more generous for KICs than other companies.
- For most companies, the first EIS qualifying investment must be made not later than the end of the seventh year following the company’s first commercial sale.
- Any investor who already has shares in a company will not be able to obtain EIS relief on a future investment if the shares already held did not qualify for EIS or another risk investment finance relief.
The amendments draw a distinction between KICs and other companies.
- A KIC is a company which:
- has R&D costs that are at least 15% of the company’s operating costs in at least one of the previous three years (or at least 10% in each of the previous three years);
- and either:
- has created, is creating or intending to create, IP; or
- has employees with a relevant Masters or higher degree who are engaged in R&D or innovation and comprise at least 20% of the company’s total workforce.
The suggested changes will apply to both EIS and VCT (Venture Capital Trust) investments. References to EIS in the summary below can, in most cases, be taken to include VCT as well. References to ‘risk finance investment’ mean EIS, VCT and Social Investment Tax Relief.
The main measures proposed have the following effect:
Impose an age limit on a company that is eligible for investment under EIS
A company must raise its first investment under EIS no later than the seventh anniversary of its first commercial sale (10 years if the company is a KIC). No age limit will apply to companies raising an investment where the amount of the investment is at least 50% of the company’s average annual turnover over the previous 5 years.
Cap the total amount of tax-advantaged investment a company may receive over its lifetime
In addition to the cap on annual investments of £5m, a new cap will be introduced on the total amount of investments a company may raise over its lifetime under EIS or other risk finance investments of £12m (or £20m for a KIC).
Stop the use of EIS money for acquisitions of businesses
Finance raised through EIS must be used for a ‘qualifying business activity’. The following will cease to be qualifying for these purposes: (a) acquiring shares in a company that is already, or will become as a result of the acquisition, a 51% subsidiary of the issuing company; (b) acquiring a trade; (c) acquiring intangible assets or goodwill to be employed for the purposes of a trade.
Restrict EIS relief where existing investments have not qualified
If an individual subscribes for shares in a company and that individual already holds shares in the company, the new shares will not be eligible for EIS unless the individual has made a risk finance investment in the company (in most circumstances this will be an EIS or SEIS qualifying investment) before Royal Assent.
Place a limit on the overall life of the EIS scheme
This was not announced in the Budget, but the draft legislation in Finance Bill 2015 states that only shares issued before 6 April 2025 will qualify for EIS.
As noted above, HM Treasury expects these changes to bring in an additional £225m of tax over the next 5 years, which suggests far fewer investors or companies qualifying for the relief.
It is difficult to know which of these changes is likely to be most disadvantageous, but the requirement for shares already held by investors in a company to be EIS shares could shut a number of investors out of the relief.
It is not uncommon in very early stage companies for shares to be issued (without much thought to the tax implications) to any investor who is prepared to put seed money into a venture, including friends and family of an entrepreneur or inventor. Then to prevent that investor from accessing tax reliefs on a later funding round seems unreasonably harsh.
While the proposals have been turned into draft legislation in the current Finance Bill, HMRC and HM Treasury are running a consultation forum in order to discuss the real implications for the businesses that rely on these risk finance investment reliefs in order to survive. We can only hope that the more disadvantageous elements are softened a little as the consultation process moves along.