When two EIS companies merge it isn't possible to structure the transaction without one of them losing its EIS relief.

The Enterprise Investment Scheme ("EIS") is designed to encourage investment in smaller trading companies by offering tax reliefs to investors purchasing new shares in EIS companies. Both Income Tax relief and Capital Gains Tax exemptions are available. However, these tax reliefs can be unintentionally forfeited when two EIS companies are merged.

In Averil Finn and others v HMRC [2014], the Appellants had subscribed for shares in a start-up company, ProtonStar LED Limited ("ProtonStar"), and satisfied the requirements to claim EIS relief on those shares.

Subsequently, a reverse take-over of another company that had secured EIS relief, Enfis Limited ("Enfis"), was executed so that ProtonStar could take the benefit of Enfis' non-transferrable AIM listing. To this end, Enfis moved its trade to a newly-formed subsidiary, acquired all of the shares in Protonstar in exchange for 78% control of Enfis and changed the name of Enfis to ProtonStar LED Group Plc ("Group"). The old Enfis shareholders, naturally, retained 22% of the shareholding in Enfis. The result left Group holding both ProtonStar and the new subsidiary of Enfis.

Under s185 Income Tax Act 2007 ("ITA"), EIS relief will be forfeited where the relevant company comes under the control of another company i.e. if it becomes a 51% subsidiary of another company. Further, s 209 provides that EIS relief will be partially or wholly withdrawn if the shareholders dispose of their shares within the relevant period.

In finding that the pre-existing shareholders in ProtonStar forfeited their EIS relief on the takeover, the First-tier Tribunal expressed surprise that s 237 ITA offers protection from forfeiture of relief in the narrow situation of the super-imposition of a pure new holding company whilst not protecting relief in the event of an entirely commercial pure share takeover of one EIS company by another.

The decision turned on a strict interpretation of s 247(1)(a) ITA, which states that EIS relief may continue where a company "in which the only issued shares are subscriber shares" acquires another company. It was held that "subscriber shares" could only be interpreted to mean "shares that are to be issued to those who subscribe to the Memorandum of Association" of a company on its initial formation. As a result, because Enfin had issued shares on different occasions, it was clear that the shares issued by it were not all subscriber shares (as narrowly defined).

The result was that the shareholders in ProtonStar could not rely on s247 to continue their EIS relief where ss 185 and 209 had been engaged.  

This case demonstrates how companies can fall foul of the EIS relief forfeiture, even following the merger of two companies entitled to the relief. The court, although entirely sympathetic to the Appellants, was obliged to adopt a strict interpretation of the legislation.

As a final point, the court noted that the shareholders would not have forfeited their EIS relief had the transaction been structured differently (i.e. by imposing a pure new holding company on top of the two EIS companies), though it seems that there is no way to merge to EIS companies without one of them losing the relief.