I often get questions from clients about whether they can claim EIS relief when investing in a company, and how to go about doing so. The following isn’t specific to any particular investment, but should give you a general overview of the things to keep in mind.
What is EIS?
The Enterprise Investment Scheme (EIS) is designed to encourage entrepreneurship and assist small, higher risk trading companies raise finance by offering tax relief to investors purchasing shares in the company.
How does it work?
If the company you’re investing in qualifies, EIS will give you the following benefits on the subscription of shares:
- your income tax relief will be limited to the lower of 20% of the amount subscribed (the minimum amount being £500 and the maximum amount subscribed being £500,000) and your tax liability for the year in which the investment is made; and
- any gain you make on the EIS shares is free from capital gains tax on sale, provided you hold the shares for at least 3 years (and the income tax relief has not been withdrawn within those 3 years) (“Investment Reliefs”).
- You can defer any capital gains made if you dispose an asset, by reinvesting the gain into the subscription for shares in a “qualifying company”. There is no maximum limit when it comes to this relief (“Reinvestment Relief”).
Can I claim it?
Unfortunately, when it comes to the Investment Relief, there are some significant restrictions which mean it’s more likely to be available to an outside investor than to someone who works in the business. However, with a little care and close attention to detail and timing, you can get it when setting up a business too.
Unfortunately, if you fall into one of the following categories, you cannot claim Investment Relief:
- Your interest in the company (or your associates) exceeds 30%. Interest is measured by any holdings of shares and/or loan capital, voting powers or entitlement to assets on a winding up;
- You’re an employee of the company (and not a director);
- You are a paid director, unless:
- you only became a paid director after the issue of shares;
- the remuneration received by you as a director is reasonable for the services performed; and
- at the point when you were issued with shares, you were not and had never been connected to the company’s business in any way (whether on your account or as a partner, paid director or employee).
Note: You’ll see that timing is critical here: the key is to make the investment into the company right at the start of the relationship/project – before you become a paid director. EIS can therefore be used for management buy-ins, but not for management buy-outs since you would have been connected with the company beforehand.
- Your associate holds the shares – so there’s no use putting the shares into the name of say, a spouse, as they will also be caught by these rules.
On the plus side, these rules do not apply to Reinvestment Relief, which is usually available to both outside investors and people working in the business. You can claim this relief, as long as:
- you reinvest a gain which you received by disposing an asset, by subscribing for shares in a qualifying company; and [
- the shares are issued at any time beginning one year before and ending 3 years after you disposed of the asset.
What do I need to qualify?
For both types of relief the following conditions must be met:
- The shares must be eligible – i.e. new ordinary shares which are fully paid up in cash. They cannot carry any preferential right to dividends, to be redeemed or to the company’s assets on its winding up.
- The shares must be issued to raise money for the purpose of a qualifying business activity. The money raised must be used within 2 years of the share issue.
- The company must be an unquoted trading company trading on qualifying activities or an unquoted Parent Company of a trading group. Qualifying activities include qualifying trades and research and development but are generally considered on a case by case basis.
- The company can only raise £2 million in any 12 month period. The value of the company’s gross assets must not exceed £7 million immediately before the issue of the eligible shares and must not exceed £8 million immediately afterwards.
- There are rules as to the extent to which the company can own or control other companies (and to which other companies can hold shares and investments in the company itself).
Any drawbacks I should know about?
Yes – you need to be aware that:
- The above conditions need to be satisfied after the investment, generally for 3 years. If not, then the relief fails.
- The rules include detailed anti-avoidance provisions which deny relief in various circumstances including where you receive value from the company or if you have a guaranteed exit.
- The relief will be lost if you dispose of the shares within 3 years. Where you dispose of the shares after 3 years, the Investment Relief is generally secure, but the deferred gain claimed through Reinvestment Relief is crystallised.