Our July 2022 blog gave an overview of the VCT funding landscape for companies that have gone through an initial ‘Series A’ fundraising round.
As mentioned in that blog, High Net Worth Individuals (“HNWI”) and Angel investors are often the sources of Series A funding to scale up the business, once proof of concept has been established and paying customers have been obtained.
Such investors will often want their investments to qualify for tax relief under EIS and in this blog, we will give an overview of the EIS.
Please note that the EIS rules are complex and this blog only picks out some aspects of them. A detailed review of all the rules should be undertaken prior to making an investment for which EIS tax relief will be sought.
The objective of the EIS is to attract funding for early-stage companies while removing some of the barriers preventing access to funds from other sources e.g., bank loans which require a business owner to provide personal guarantees.
The EIS seeks to do this by offering generous tax relief to individual investors who subscribe to new shares in qualifying trading companies.
What are the tax benefits for an investor?
The following tax reliefs are available to investors in EIS qualifying companies:
Income Tax Relief
30% income tax relief on investments up to £1 million per tax year (this is increased to £2 million for investment in a ‘knowledge-intensive company’ or ‘KIC’).
Loss Relief
If the shares are disposed of at a loss, investors can set the loss against other gains or their general income of that tax year or the preceding year.
Capital Gains Tax (CGT) Disposal Relief
If the shares are disposed of at a gain, that gain is exempt from CGT, providing the EIS-qualifying shares have been held for at least three years and income tax relief for the subscription has not been withdrawn.
CGT Reinvestment Relief
The gain arising from a disposal of non-EIS assets can be deferred if the gain is reinvested in EIS-qualifying shares. The deferred gain will, however, come back into charge, for example when the EIS shares are sold.
There are strict conditions for both the company and the investor
There are strict conditions that must be satisfied by both the company and the investor in order for the above generous tax treatment to be available.
Some of these are set out below, but a detailed review of all the requirements would be required if you are thinking of making a claim for EIS tax relief.
EIS funding is targeted at early-stage independent unlisted trading companies that have a ‘permanent establishment’ in the UK, which comply with various age (i.e., the company must receive its first ‘relevant investment’ within seven years of its first commercial sale or 10 years for KICs) and size limits (i.e., gross assets not exceeding £15 million prior to the EIS share issue and not exceeding £16 million immediately after it; and fewer than 250 full-time equivalent employees).
The trade must not be one of the certain excluded activities such as dealing in land, banking, property development, farming, operating and managing hotels, nursing homes or residential care homes.
There are also restrictions on what the money raised from EIS investments can be spent on and when it can be spent. The company must use the money raised by the new share issue for a qualifying business activity and for growing or developing that business. The money raised must also be spent within two years of the company receiving the investment, or if later, the date the business started trading. The money cannot be used to buy all or part of another business.
The aim of the EIS is to attract outside investors. As a result, the scheme does not allow investors who are ‘connected’ with the company to obtain tax relief. Broadly speaking, individuals that are either employees or directors of the company or hold more than 30% of the company’s share capital (together with their ‘associates’) are excluded from making an EIS investment in that company. However, there are relaxations for Angel investors in certain circumstances.
A further point to note is that there is currently a ‘sunset clause’ on the EIS so that income tax relief will no longer be given to EIS shares subscribed for on or after 6 April 2025.
Seed Enterprise Investment Scheme (SEIS)
This is another venture capital tax relief that is targeted at start-ups before they access EIS investments. The September Mini-Budget included announcements that will make this relief more accessible from April 2023 and we will cover the SEIS and these changes in a subsequent blog.
How We Can Help
There are numerous detailed conditions that must be satisfied by both an investor and a company in order for EIS tax relief to be available. At MHA Moore and Smalley, we can help both companies and individuals navigate the complex EIS tax rules.
If you would like more information regarding EIS or other issues surrounding equity investment, please contact us by completing the form here.