The Enterprise Investment Scheme (EIS) helps unquoted trading companies raise equity finance by offering a range of tax incentives to their investors.
The tax reliefs in brief
The tax reliefs available to investors in enterprise investment scheme (EIS) qualifying companies are:
- Income tax relief of up to 30% of the sum invested
- Exemption from capital gains tax (CGT)
- CGT deferral relief
- Exemption from inheritance tax
- Loss relief.
Although the tax reliefs are available only to the investors, and not the company itself, the intention is that an EIS company will be attractive to potential investors, thus helping it raise finance.
A company can raise up to £12m from a combination of EIS and Seed EIS investors, Venture capital trusts and other forms of State aid risk capital, over its lifetime, but not more than £5m in any one 12 month period.
Knowledge intensive companies (KICs)
Since 6 April 2018, a KIC can raise up to £10m in a single year and £20m in total State aid investment. KICs also benefit from a 10-year ‘initial investing period’ and a higher employee limit of 499. There are also advantageous rules regarding when a KIC’s initial investing period starts.
EIS qualifying companies have to satisfy a number of requirements at the time of the share issue and for the following three years.
When the shares are issued, the company must:
- Have gross assets of less than £15m, and no more than £16m immediately after the share issue
- Have fewer than 250 ‘full time equivalent’ employees
- Be unquoted or on AIM or NEX Growth, and have no arrangements in place to become quoted on a recognised stock exchange.
At the time of the share issue AND for three years after the share issue, the company must:
- Be independent, ie not under the control of another company
- Conduct a qualifying trade
- Have a UK ‘permanent establishment’, though trading mainly in the UK is no longer a requirement.
There are also anti-avoidance rules to counter pre-arranged exits and any arrangements designed to reduce an investor’s risk.
Additionally, all money raised from the issue of EIS and VCT shares must be used to grow and develop the business, and must not be used to make acquisitions of either another company’s shares, trade or certain types of trading asset.
Qualifying company rules
The EIS is intended to encourage investment in higher risk, trading companies, so a number of types of trade are excluded. These are:
- Dealing in land, shares, futures and other financial instruments
- Dealing in goods other than in the normal course of a retail or wholesale trade
- Banking, insurance, money lending or other financial activities
- Leasing or receiving royalties or license fees, unless the company has created the intangible asset itself
- Providing legal or accountancy services
- Farming, market gardening, woodlands and timber production.
- Property development
- Hotels and nursing homes
- The generation or production of heat, electricity, power, fuel or gas
- Coal and steel production, shipbuilding
- Providing services to a connected party conducting one of the above trades.
A stated aim of the EIS is to attract outside investors to companies. As a result, the scheme denies EIS relief to investors who are ‘connected’ with the company. This includes:
- Employees or directors of the company
- Investors who (together with their ‘associates’) hold more than 30 per cent of the company’s share capital
- Relatives of connected persons, though not siblings
- Business partners of connected persons
- Existing shareholders whose shares are not SEIS or EIS qualifying, or subscriber shares
- There are provisions for ‘Business Angels’, enabling certain investors to become directors.
The seven-year rule
A company which has been trading for more than seven years (measured from its first commercial sale), and which did not issue EIS, SEIS or VCT shares in its first seven years (the ‘initial investing period’), is excluded from EIS investment unless it raises EIS/VCT money amounting to at least 50% of its five year average turnover, and spends that money on entering a new product market or geographic market.
The shares issued must be full risk, ordinary shares or non-cumulative fixed preference shares. No linked loans are allowed, and there must be no protection offered to shield investors from risk.
How does the company obtain EIS qualifying status?
Many potential investors will want some form of comfort that their investment will qualify for the EIS tax reliefs.
It is possible to obtain ‘advance assurance’ from HMRC before issuing shares to investors, and many potential investors will insist on this. Advance assurance is not a requirement of the EIS, and does not guarantee that a share issue will qualify, but it is useful, both in attracting investors and in ironing out any problems before it is too late.
After the shares have been issued, and the Company has traded for four months, the Company makes a declaration on a form EIS1, and provides details of the investors to HMRC. All being well, the company will be authorised to issue the EIS3 certificate to investors, enabling them to claim their tax reliefs.
How can we help?
If you would like more information about the EIS or other issues surrounding equity investment in your business, please contact your usual BDO contact or Sean Lavery, Maybeth Shaw or Paul McCourt.
Knowledge Intensive Companies
Enterprise Investment Scheme Guide for investors