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HMRC have recently updated their guidance for companies looking to attract investors to buy shares in their company. If structured correctly, and if the company qualifies under the Enterprise Investment Scheme (EIS) or the Seed EIS rules, investors can potentially take advantage of a number of very generous tax breaks.
Under the EIS, the company can raise up to £5 million each year, with a maximum of £12 million raised in the company’s lifetime. This includes amounts received from other venture capital schemes also. The company must receive investment under a venture capital scheme within 7 years of its first commercial sale.
The size of the issuing company is crucial as it and any qualifying subsidiaries must:
- not have gross assets worth more than £15 million before any shares are issued.
- not have more than £16 million immediately after any shares are issued.
- have less than 250 full-time equivalent employees at the time the shares are issued.
The investment must meet the “risk to capital” condition, which means:
- the company must use the money for growth and development.
- the investment must be a risk to the investors’ capital.
‘Growth and development’ means the company will use the investment to grow things like its revenue, customer base or the number of employees.
There are several other complex scheme rules that need to be followed so that the investors can claim and keep EIS tax reliefs relating to their shares. Tax reliefs will be withheld or withdrawn from the investors if they, and the company, do not follow the rules for at least 3 years after the investment is made.
It is a good idea to apply for Advance Assurance from HMRC that the company is an ‘EIS qualifying company’ before the shares are issued.
Seed EIS (SEIS) is designed to encourage investment in small start-up companies and provides a number of tax breaks for individuals who buy new shares in a company. However, the company must not have been trading for more than 2 years when the SEIS shares are issued.
Only the first £150,000 of share capital raised by the company qualifies for Seed EIS relief. However, this can form part of a larger share issue with subsequent share issues qualifying for EIS relief up to a £5 million annual limit.
Like EIS, the tax reliefs will be withheld or withdrawn, from investors if the rules are not followed for at least 3 years after the investment is made.
There is a key condition that the company is an unquoted company carrying on, or preparing to carry out, a qualifying trade at the time that the shares are issued.
Another important condition to qualify under Seed EIS is the company and any of its subsidiaries must:
- not have gross assets over £200,000 when the shares are issued.
- not be a member of a partnership.
- have less than 25 full-time equivalent employees in total when the shares are issued.
Like EIS, it is advisable to apply for Advance Assurance from HMRC that the company is a qualifying company before the shares are issued. For more details see: Use the Seed Enterprise Investment Scheme to raise money for your company – GOV.UK (www.gov.uk)
Tax Breaks for SEIS Company Investors
Investors who are not connected with the company may claim income tax relief of 50% of the amount that they invest in qualifying SEIS companies, up to £150,000 in each tax year. Thus, a £10,000 investment would result in a £5,000 reduction in the investor’s income tax liability.
The connected persons tests are complicated and similar to the EIS rules. Nevertheless, directors can claim SEIS tax relief.
Provided that the shares are held for at least 3 years, the income tax relief is retained and any gain on disposal of the shares would be exempt from capital gains tax.
One further relief for SEIS investors is that 50% of the amount invested may be set against capital gains that year. Thus, a £10,000 investment would mean that the investor could deduct £5,000 from their capital gains that year in addition to the £5,000 reduction in their income tax liability.
Tax Breaks for EIS Company Investors
Investors who are not connected with the company may claim income tax relief of 30% of the amount that they invest in qualifying EIS companies up to £1 million each tax year. So, a £10,000 investment would result in a £3,000 reduction in the investor’s income tax liability.
The connected person tests are complicated as directors cannot claim EIS tax relief if, at the time the shares are issued, they are a paid director of the company – unless the payment is a ‘permitted payment’. However, they may become a paid director after their investment under the ‘business angel’ rule.
Provided the shares are held for at least 3 years, the income tax relief is retained and any gain on disposal of the shares would be exempt from capital gains tax.
It is also possible to defer capital gains on any asset disposal by reinvesting the gain in qualifying EIS shares.
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