SEIS and EIS for raising investment
For years, entrepreneurs have struggled to obtain long-term funds for their start-ups and small businesses. In turn, investors are often hesitant to provide venture capital for unquoted companies because of the high level of risk involved.
The Business Start-Up Scheme (BSUS) was launched in 1981 in the hopes that offering tax incentives to investors would encourage them to purchase shares in small trading companies. The scheme developed into the Business Expansion Scheme (BES) in 1983 but, by the early nineties, it became obvious that it was being used by investors primarily for tax relief rather than in the interest of business development.
The introduction of the Enterprise Investment Scheme
Because investors were focusing mainly on the offer of up-front tax relief and the inclusion of property companies in the eligibility criteria, BES was phased out in 1993 in favour of the Enterprise Investment Schemes (EIS).
Speaking at the November 1993 budget, Michael Portillo, Chief Secretary to the Treasury at the time, said that the EIS objective was to “recognise that unquoted trading companies can often face considerable difficulties in realising relatively small amounts of share capital.”
The scheme brought in a stricter set of eligibility criteria for vetting potential investors and companies alike and, by 2012, its success warranted the creation of the Seed Enterprise Investment Scheme (SEIS). SEIS focused on smaller businesses, narrowing down the options available to investors into two very specific categories.
Are you a director aiming to raise investment in your company? Maybe you’re an investor looking to provide capital for an entrepreneurial venture worthy of your cash but you’d like some direction on the tax benefits and the risk factor?
Whichever category you find yourself in, this article will provide you with everything you need to know about the two systems.
Plant a seed, watch it grow – How SEIS works for investors and businesses alike
If you’re looking to invest in a smaller company and still receive substantial tax benefits, SEIS is the scheme for you.
To qualify as an investor, you can’t be employed by the company you wish to invest in, and your investment mustn’t exceed £100,000 per tax year. SEIS dictates that any shares bought must be held for a minimum of 3 years to qualify for tax relief so if liquidity is important to you, you’ll need to sit down and determine whether you need access to this cash for the next three years.
As for the company you’re looking to invest in, SEIS rule states that it must have fewer than 25 full time or equivalent staff, be less than 2 years old, and have less than £200,000 in gross assets.
Shares you buy are exempt from inheritance tax as long as you’ve owned the share for a minimum of 2 years.
What about the tax relief?
Income tax relief is set at 50% of your investment.
This means that in the case of a £10,000 investment into an SEIS qualifying company, £5,000 can be deducted from your income tax bill – if you hold onto the shares for a minimum of 3 years.
For timeframes, you can claim for this relief up to 5 years after the 31st January following the financial tax year in which the investment was made. There’s also the option of treating the shares as having been issued during the previous tax year if you want to use up income tax relief from that period.
Important: Income tax relief doesn’t apply if you own more than 30% of a company’s share capital, or control more than 30% of its voting rights. Ensure investors in your company are aware of this.
SEIS Capital Gains Tax (CGT) exemption relief
Should you wish to access yet another incentive, the scheme allows an investor to defer 50% of their Capital Gains Tax up to the amount of investment.
Continuing with the previous example, your investment of £10,000 into the SEIS qualifying company would save you £1,400 in tax. With CGT at 28%, normal taxation on £10,000 would be £2,800. With your additional 50% relief, the total relief is £1,400.
Investors should note that if you dispose of the SEIS shares, cease to be a UK resident, or the SEIS shares cease to be eligible within three years of the initial investment, CGT may become repayable to HMRC.
Important: With CGT currently at 10% for basic tax payers, relief in the scenario described above would fall to £500. Higher rate tax payers experience CGT at 20% so the relief would be £1000.
SEIS Capital Gains Tax (CGT) exemption
Let’s suppose you wish to withdraw your support from the company you invested £10,000 in. After three years of holding your shares, you can claim exemption from CGT for the shares which originally qualified for income tax relief.
What if income tax relief wasn’t granted on the full amount you invested? Well, you can still claim a proportion of the gain with your CGT exemption.
SEIS relief for losses
If your investment of £10,000 ends up spiralling down the proverbial drain along with any trace of the business itself, SEIS offers a safety net incentive.
Put simply, if your loss is greater than the amount you claimed in income tax relief during your shareholding investment period, you’re entitled to benefit from further income tax relief at your usual payable rate.
Below is an example of how a failed investment of £15,000 would affect basic, higher and additional rate taxpayers.
| 20% | 40% | 45% | |
|---|---|---|---|
| Your original investment | £15,000 | £15,000 | £15,000 |
| Income tax relief | £7,500 | £7,500 | £7,500 |
| CGT relief | £2,100 | £2,100 | £2,100 |
| Loss incurred | £5,400 | £5,400 | £5,400 |
| Loss relief | £3,375 | £3,000 | £1,500 |
| Net loss | £2,025 | £2,400 | £3,900 |
There is a lot to like about SEIS for both entrepreneur and investor.
If you’re interested in the incentives shown above but you’re looking to invest or raise investment of a larger value, EIS may be the scheme for you.
Big dreams, bigger investments - The Enterprise Investment Scheme (EIS)
The EIS system has survived twenty years of economic change (and occasional tumult) and it continues to be popular among investors. “The investment risks, including volatility, default and liquidity, have decreased significantly for the average EIS investor,” according to Ewoude Karelse, Head of Tax Advantaged Investments at Tilney.
The Chancellor, in his Autumn Budget of 2017, promoted EIS as the preferred way of generating growth capital for small businesses in the UK. To back up his enthusiasm, he announced an increase in the fundraising limits for knowledge-intensive companies by raising the threshold from £5million to £10million per year.
Not only that, but the individual investor limit has doubled to £2million where investments are going into knowledge-intensive companies which should, in theory, encourage more people to fully utilise their EIS allowance.
Currently, standard EIS investment is capped at £1,000,000. After two years, your investment qualifies for Business Property Relief.
So – do I or my company qualify for EIS?
As an investor, the rules mirror those of the SEIS criteria. You must have no more than 30% sway in the company, whether that be in shares or voting power. In this case, the rules surrounding tax avoidance are much stricter and should an investor apply to enter the scheme with an intention in mind, they would find themselves unqualified to participate if HMRC found out.
The maximum gross assets pre-investment of a business entering EIS can’t exceed £15million. Also, if the business itself employs more than 250 full-time staff (or equivalent), it will not qualify for EIS.
Regarding the capital, the total amount raised must be used in the company within 24 months of investment, and the company in question must be neither quoted (except listings on markets like AIM, ISDX etc.) nor in the following industries: coal/steel production, farming, property development, leasing, or financial services.
Upon application, the investment will have to be approved by an audit tax officer which is why it’s imperative to adhere to the guidelines governing the scheme.
Every investment comes with a risk factor – So, why EIS?
The methodology behind EIS isn’t risk free, as with any other investment, but it does provide a substantial safety net and a shopping list of incentives.
If liquidity in your investments is important to you, be aware that you’ll need to hold onto your shares for a minimum of three years before you cash them in. Take into account that selling your shares might be difficult, and that there’s a possibility you might not find buyers during or after the three years you hold the shares.
There are numerous tax reliefs available for investors in EIS-qualifying companies designed to mitigate for the high risk of failures in EIS companies.
However, should you choose to bite the bullet, ensuring you choose the right business to invest in is going to be your hardest decision.
Rather than making a decision based purely on capital preservation, EIS urges investors to put their money into businesses with obvious promise – talented and level-headed staff, excellent financial management, and a tendency to either hit or exceed sales forecasts.
Should you invest in such a company, the potential for growth is huge.
What about tax relief? As a business director looking to attract interest in your company, it’s imperative you communicate the incentives available under EIS to potential investors.
EIS income tax relief
Income tax is set at 30%, meaning that if you decide to invest £10,000 into an EIS-approved business, you can benefit from a £3,000 reduction on your Income Tax bill.
Again, you must hold onto your shares for three years after the investment takes place in order to qualify for this relief, and if you paid less than £3,000 in income tax during that financial year, you’re only eligible to claim back for the amount of income tax that you did pay.
Here, the 30% rule applies just as it does in the negotiation of SEIS eligibility. Income tax relief cannot be claimed if the investor either owned 30% or more of the issued share capital or controlled more than 30% of its voting rights. This is applicable from two years before EIS shares were issued and ending three years after they were issued.
Similarly, you cannot be employed by the company in any way, whether it be by a director, by any of the company’s subsidiaries, or through a partner of the company or its subsidiaries.
There is scrutiny on the level of involvement an investor has within a company under the EIS scheme, so it’s best to check your status and bring any queries you have to your accountant before applying.
EIS Capital Gains (CGT) exemption
If you hold onto your shares for 3 years or more, you’re eligible to claim for exemption from GCT for shares which qualified for income tax relief. Make sure to claim back a proportion of the gain with your CGT exemption should you find that income tax relief was not granted on the full sum you invested.
What happens if my investment tanks? – EIS relief for losses
Say you invested £10,000 into a promising business, but it descends into liquidation leaving you - quite literally - at a loss. How can EIS tax reliefs help soothe the burn?
| 20% | 40% | 45% | |
|---|---|---|---|
| Your original investment | £15,000 | £15,000 | £15,000 |
| Income tax relief | £4,500 | £4,500 | £4,500 |
| Net cost to investor | £10,500 | £10,500 | £10,500 |
| Loss relief | £3,150 | £4,200 | £4,725 |
| Cost to investor after tax | £7,350 | £6,300 | £5,775 |
EIS Capital Gains Tax (CGT) deferral relief
Let’s say you dispose of some assets and make a substantial gain. If in the one year prior to the gain accumulation, or in the three years following, you made an EIS investment, you could benefit from deferring your CGT using your investment tax relief.
As with everything else, there are criteria that; if fulfilled; will render you unqualified for CGT deferral relief. Should you dispose of the EIS shares, cease to be a UK resident, or should the EIS shares cease to be eligible within three years of you making the investment, your CGT deferral relief may become repayable to HMRC.
Important: Deferment isn’t always the best way forward, and can sometimes work against you, so it’s always wise to talk over any concerns or queries you may have with your accountant.
EIS Capital Gains Tax (CGT) disposal relief
An investor may, under certain conditions, be eligible to claim EIS CGT Disposal relief. This means that Capital Gains Tax is not due on a gain on the investor’s disposal of the EIS shares.
You will meet the conditions if you have held the EIS shares for a minimum of three years, or if you have received Income Tax relief on the whole of your subscription(s) for the EIS shares and none of the Income Tax relief has been withdrawn.
Ineligibility to claim EIS CGT Disposal relief occurs when the investor sells EIS shares within 3 years of the date they were issued. Should they sell the shares (not including to a spouse or civil partner), income tax relief in respect of those sold will be wholly or partly withdrawn. If you make a gain on the disposal, it will be subject to capital gains tax.
Summing up
The SEIS and EIS schemes are attractive for both business builders and for investors.
If you want to attract investment in your firm using either of these schemes, or you are a new investor yourself into these schemes, it pays to talk to your Panthera accountant.
Call us today on 01235 768 561 to speak with your usual Panthera partner.