Seed Enterprise Investment Schemes & Enterprise Investment Schemes

Many startup firms struggle to raise the capital needed in order to get their new ideas or products to market. With the obvious risks involved in investing in companies with limited or no track record, only the most highly informed or deeply pocketed investors have the appetite for the level of risk involved.

With this in mind, the Government established the Enterprise Investment Scheme (EIS) in 1994 and the Seed Enterprise Investment Scheme (SEIS) in April 2012, both of which provide generous tax breaks to investors willing to support nascent businesses. Both schemes operate in similar ways, however, the SEIS is more focused on supporting businesses in their infancy whereas the EIS is geared towards larger and more established businesses requiring larger investments.

For budding entrepreneurs the benefits of the schemes are obvious: more investors being able and willing to provide much needed capital. But beyond this, you need to have a greater idea of how to market yourself as being EIS and SEIS investable, and the rules that you must abide by for your business to qualify for the reliefs..

The following is only intended to provide a general guide to these two schemes, and therefore you should take professional advice to establish your eligibility before pursuing either scheme.

SEED ENTERPRISE INVESTMENT SCHEMES (SEIS)

Benefits

Provided the SEIS shares are ordinary shares and fully paid in cash:

  • Income Tax Relief: Subject to the SEIS shares being held for at least 3 years, investors get a reduction in their Income Tax bill of 50% on SEIS investments made up to £100,000 per year.  This gives an equal tax benefit to all taxpayers irrespective of their level of income, as the relief is (unusually) a deduction from the tax bill rather than from the pre-tax income.  There is also a carry-back facility for 2013/14 onwards.
  • CGT Disposal Relief: Should the investor sell their SEIS investment at a gain, no Capital Gains Tax is payable on that gain.
  • Loss Relief: If they sell at a loss, the loss (less any already claimed Income Tax relief) can be set against the investor’s income in the year of disposal or the previous year, rather than against any capital gains.
  • CGT Re-Investment Relief: If an investor disposes of an asset creating a chargeable gain which is then re-invested in SEIS shares, that gain may be CGT exempt.  For gains from 2012-13 100% relief applies.  For gains from 2013-14, only 50% relief applies.  Whilst claims for this relief can still be made, the relief does not apply to years post 2013-14.

Furthermore, SEIS shares held for at least two years will also normally qualify for 100% business property relief for Inheritance Tax purposes.

Who Qualifies?

The type of company which qualifies for SEIS must be deemed a “qualifying company”, meaning it must:

  • be an unlisted UK registered company and no older than 2 years when the SEIS shares are issued;
  • have a total gross asset value of less than £200,000 prior to the SEIS investment;
  • have fewer than 25 employees, including directors, at the time of issue;
  • not receive more than £150,000 in total under the SEIS per year;
  • not be part of a partnership or a 51% subsidiary of another company at any time from incorporation to 3 years after the relevant SEIS share issue;
  • not have received any previous investment through the EIS (see below) or any Venture Capital Trust; and
  • be carrying on a “qualifying trade” which is essentially any trade conducted on a commercial basis with a view to make profits, provided that trade does not include a substantial amount of the “excluded activities” which include:

•  dealing in land, shares or commodities;
•  property development;
•  farming;
•  operation or management of hotels or nursing homes;
•  financial activities;
•  leasing;
•  shipbuilding and coal and steel trades;
•  receiving royalties and licence fees.

There is, however, no requirement that a company has started actively trading before raising capital via the SEIS.

The type of investor who qualifies must:

  • be purchasing shares for genuine commercial reasons and not for tax avoidance;
  • not invest above the SEIS limit of £100,000 per year;
  • not hold a stake of over 30% in the company, either personally or with associates (e.g. business partners and relatives), at any time from incorporation to 3 years after the relevant SEIS share issue;
  • not be an employee of the company for the first 3 years from issue of the SEIS shares, unless they are also a director; and
  • not receive a loan from the company linked to their SEIS share subscription at any time from incorporation to 3 years after the relevant SEIS share issue.

Ongoing Aspects

In order for the SEIS tax reliefs to remain effective, the company must:

  • continue carrying on a “qualifying trade” as defined above;
  • use the funds raised (aside from incidental amounts) for the purpose of the qualifying business activity within 3 years;
  • use 70% of the SEIS funds before funds can be raised under the EIS or venture capital schemes.

Furthermore, the investor must:

  • hold the SEIS shares for 3 years or more; and
  • not receive any value from the company for the first 3 years apart from “ordinary commercial payments” (e.g. dividends).

ENTERPRISE INVESTMENT SCHEMES (EIS)

Benefits

Provided the EIS shares are ordinary shares and fully paid in cash:

  • Income Tax Relief: Subject to the EIS shares being held for at least 3 years, investors get a reduction in their Income Tax bill of 30% on EIS investments made up to £1 million per year, provided the EIS shares are held for at least 3 years.  This gives a maximum tax reduction in any one year of £300,000.  The amount invested can be carried back to the previous tax year for relief purposes.
  • CGT Disposal Relief: Should the investor sell their EIS investment at a gain, no Capital Gains Tax is payable on that gain.
  • Loss Relief: If they sell at a loss, that loss, less any Income Tax relief already given, can be set against the investor’s income in the year of disposal, rather than set against their capital gains.
  • CGT Deferral Relief: Unlimited gains on other assets can be deferred by reinvesting those gains into the EIS within 1 year before or 3 years after the gain occurred.  Those gains then become chargeable if certain events occur at a later date.

Furthermore, EIS shares held for at least two years will also normally qualify for 100% business property relief for Inheritance Tax purposes.

Who qualifies?

Again, the company must be deemed a “qualifying company”, meaning the company:

  • must not have gross assets exceeding £15 million in value immediately before the EIS shares are issued and £16 million immediately afterwards;
  • must not be a quoted company when the EIS shares are allotted;
  • must exist wholly for the purpose of carrying on a “qualifying trade” and not include a substantial amount of “excluded activities” (see above);
  • must have fewer than 250 full-time employees; and
  • cannot raise more than £5 million in total over a 1 year period under the EIS.

The investor:

  • must be purchasing the EIS shares for genuine commercial reasons and not tax avoidance;
  • cannot hold a stake of over 30% in the company, either personally or with associates (e.g. business partners and relatives);
  • must not be, or have been, connected with the company as an employee or paid director, or somehow involved with the carrying on of its business prior to acquiring the EIS shares (but they can become a paid director afterwards).

Ongoing Aspects

In order for the EIS tax reliefs to remain effective, the company must:

  • continue to carry on a “qualifying trade”;
  • use the funds raised (aside from incidental amounts) for the purpose of the qualifying trade within 2 years;
  • not be a 51% (or greater) subsidiary of another company at any time from the date of issue of the shares to the end of the third years;
  • only issue shares under the EIS which are non-redeemable ordinary shares and, during the first 3 years, must not carry any preferential rights to dividends or assets on winding up; and
  • not have more than 30% of SEIS investment unspent.

Furthermore the investor must:

  • hold the EIS shares for 3 years or more;
  • not receive any value from the company for the first 3 years apart from “ordinary commercial payments” (e.g. dividends).

SUMMARY

Which of these two investment mechanisms would best suit your company’s needs will not only depend on your potential investor’s profile, but also on your company’s profile, including its business plans, forecasts, nature of industry and so forth.  There may be certain instances in which the SEIS would not be suitable, for example, if you expect your company to grow quickly and require more than £150,000 in one year, in which case the EIS would be more appropriate.  Conversely, you may be looking for a small investment in your company’s infancy, in which case the lower limits, and more favourable tax reliefs, of the SEIS may be more favourable.

It is therefore crucial that you take appropriate advice from a suitably qualified professional to decide which route of finance best suits your needs.  In doing so you would also ensure that your company qualifies for the SEIS or the EIS, allowing you to market your company accordingly.