EIS is a nutshell
The Enterprise Investment Scheme encourages investment in high-risk, small, unquoted companies by offering substantial tax incentives to investors in companies which qualify.
Which companies does EIS help?
The type of companies that EIS is intended to benefit are those which are ‘young’ and engaged in high-risk ventures. This may often involve ‘knowledge intensive’ research and development with a high-risk of failure. Such companies often find raising finance through traditional methods difficult.
How does a company raise finance through EIS?
The process in brief is that the company first ensures that it meets the conditions required by the EIS legislation to become a qualifying company, and it then issues shares which also meet the stringent requirements to be qualifying shares. This can be quite difficult as the conditions are complex and rely on the submission of correct paperwork to HMRC at the correct stages.
Advance assurance can be sought from HMRC before the issue of shares, to gain comfort that the conditions will be met, but HMRC will not be held to that assurance if circumstances change.
What are the tax incentives offered by EIS?
In summary, tax reliefs under EIS are as follows:
- income tax relief for the investor of up to 30% of the amount invested
- disposals of EIS shares after three years may be free from capital gains tax
- capital gains tax deferral relief allows investors disposing of any asset to defer gains against subscriptions in EIS shares
- losses on EIS shares may be offset against taxable income
- EIS investments should qualify for IHT business property relief after two years’ ownership
There are several conditions that the investor must also satisfy in order to be eligible for the relief. The investors must be an individual and connections with the company can adversely affect the eligibility to some of the tax reliefs. The conditions are also time sensitive in that they must be satisfied for certain periods if full relief is to be obtained.
How does the investor make the investment and claim the relief?
The investor subscribes for the shares either directly in the company or through an approved investment fund, and then the investor applies to HMRC for the tax reliefs available.
The process for claiming tax relief is quite straightforward as it simply involves following a few steps which are detailed on the scheme certificates. The certificates are provided to the investor by the company (or fund manager) after permission to do so has been received by HMRC.
Income tax relief is usually claimed in the tax year in which the qualifying shares are issued. However, it is also possible to carry back some relief, so planning to maximize the tax advantage over more than one tax year is important.
What if things go wrong after EIS tax relief has been claimed?
The conditions imposed on the company, the issue of shares and the investor are numerous, complex and are ongoing for different but interconnected periods of time. It is easy for a condition to be met at the time of the share issue and then later be broken within the time period for which it applies. In such circumstances the relief given to the investor is clawed back in part or in full.
Similarly gains deferred through EIS can become chargeable on the occurrence of a later chargeable event.
The company in receipt of the investment, and the investor, have a duty to notify HMRC if circumstances arise in which a clawback of tax relief is required, or a deferred gain becomes chargeable. Penalties can be imposed by HMRC if these obligations are not met.