Enterprise investment scheme

The investor
The qualifying company
Outline of the scheme rules
Qualifying trades
Spreading your risk
Conclusion

The EIS is a government scheme that allows certain tax reliefs for investors who subscribe for qualifying shares in qualifying industries.

What benefits does the Enterprise Investment Scheme provide the investor and companies wishing to raise new finance?

The investor can expect:

• Income tax relief at the 30% rate of tax on the amount invested in qualifying investments of up to £1 million a year. The EIS relief may be withdrawn if certain events occur within 3 years, such as shares sold. There is a further £1 million allowance per investor provided the investment in excess of £1 million is in knowledge-intensive companies.
• Any gain arising on a disposal of the shares after 3 years to be free from capital gains tax provided that any amount of income tax has been claimed
• Deferral of capital gains (no limit) on any other assets, by reinvesting all or part of the gain into an EIS company within one year before, or three years after, the gain accrued. The deferred gain becomes chargeable to capital gains tax if certain events occur later
• Relief for any losses made on the disposal of EIS shares against capital gains tax or, in some circumstances, income tax
• The opportunity to participate in the running of the business and to receive reasonable remuneration for doing so.

As a result of the above, an individual could have a total tax saving and deferral of 60% of his investment.

Spreading your risk

Investors who do not want to put all their eggs into one basket could consider an EIS approved investment fund or a venture capital trust (VCT).

Approved investment funds are collective investment vehicles employing a fund manager to invest subscribers' money in qualifying companies. The fund manager brings together the total investment of a number of investors over a number of companies.

The qualifying company

• The company can enjoy the opportunity to raise finance, either for initial startup or for expansion

The main condition is that the scheme be limited to companies with gross assets of less than £15 million before, and no more than £16 million after the investment. The company must have fewer than 250 equivalent staff. Please contact us for shares that fall outside of these criteria.

Outline of the scheme rules

Throughout its relevant 3-year qualifying period, the company must:

• Be an unquoted company
• Have only fully-paid issued shares
• Be a trading company carrying on a qualifying trade through a permanent establishment in the UK
• Exist for genuine commercial purposes and not be part of a scheme for the avoidance of tax
• Not be a 51% subsidiary of another company, or otherwise be under the control of another company.

In addition:

• An investor cannot be 'connected' with the EIS company, i.e. he or she cannot own more than 30% of the shares, directly or indirectly
• Individuals who are paid directors or employees of the EIS company at the time of the issue of shares are normally disqualified from claiming EIS relief. Otherwise, qualifying investors can in certain circumstances be paid for their work, provided the total remuneration package is 'normal and reasonable'
• The money raised by the EIS share issue must be wholly used for the qualifying business activity
• Schemes that involve guarantees or exit arrangements will not attract tax relief.

Qualifying trades

The definition of qualifying trades is quite extensive, but certain activities (such as most dealing operations, banking, leasing, legal, and accounting services) are specifically excluded, as are those considered to be 'asset backed' (farming, forestry, property development, hotels, and nursing homes). Excluded activities also include shipbuilding and steel or coal production. More recently certain trades generating or exporting electricity which will attract a Feed-in Tariff are also excluded.

Changes to the scheme now require that when the shares are issued a new ‘risk to capital’ test is met. This test requires that taking into account all the circumstances existing at the time the shares are issued it must be reasonable to conclude both that:

• The investee company has an objective to grow and develop its trade in the long-term, and

• There is a significant risk that the investor could lose more of the capital invested than they get back by way of other returns from the investment.

For the purpose of the risk to capital test:

• The risk and the return is determined with reference to the investors in general.

• Loss of capital is the loss of some or all of the amounts subscribed for the shares of the investee company.

• The return on the investment is the net investment return taking into account income from the investment, growth of capital, and the value of the EIS relief obtained in relation to the investment.

In essence this will require due diligence to ensure that this is satisfied when the shares are issued, and will take into account publicity material and the prospectus for the share issue to establish that the investment is sufficiently risky to warrant extra tax relief.

Generally speaking, knowledge-intensive companies meet additional conditions associated with research and development spend and the creation of intellectual property. These companies have more favourable conditions under EIS, including being permitted to raise more funds through the scheme than other companies.

Comparison between VCT, EIS and SEIS.

Conclusion

The scheme is becoming more and more popular, and currently there appear to be more potential investors than there are opportunities. As may be expected, the tax breaks have been introduced by the government to encourage would-be investors in what, given the nature of the investment companies concerned, must be inherently risky ventures. However, readers with an entrepreneurial spirit, surplus cash and the appetite for a healthy payback, may be interested to learn more.