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July 5, 2012
The primary tax relief takes the form of a reduction in the investor’s UK income tax relief at a rate of 30% on the amount invested. The maximum investment in any one tax year per individual is £1 million. The maximum each company can raise through the EIS (and certain other venture capital tax reliefs) is currently £2 million, but the UK Government are in negotiations with the EU to have this limit increased to £10 million (w.e.f. 6 April 2012). Additionally, any gain arising on a disposal of the shares after three years should be free of capital gains tax.
Investors can also defer any recent capital gains on any other assets by re-investing all or part of the gain into an EIS company. Losses made on the disposal of EIS shares can be set off against capital gains tax or, in some circumstances, income tax. As a result of the reliefs, an individual could have a total tax saving and deferral of nearly 60% of his investment. Conversely, if his investment totally fails, his net loss would be limited to 35% of his initial cash outlay.
Since these tax breaks are so attractive they are restricted to genuine “at risk” investments in smaller trading companies. The investment must remain in place for a minimum three year qualifying period. Currently the scheme is limited to companies with gross assets of less than £7 million before, and no more than £8 million after, the investment. The company must have fewer than 50 full time employees. EU “state aid” approval is being sought by the UK Government to increase these limits to £15/£16 million and 250 employees.
To satisfy the aim of the tax breaks, the focus is on “active” trades so financing and asset rich activities have always been excluded. Licencing of intellectual property where the value has been created by the company is expressly allowed, thereby enabling companies in the media sector such as TV and film production to qualify.
Indeed, the EIS scheme has proved most attractive to the media and film sector. A broad spectrum of companies –including film development, pre-production, production, post-production, CGI, games/aps development and music recording/production companies – have all qualified. However, the current £2 million limit has proved restrictive and the film sector in particular is awaiting news as to whether the proposed £10 million limit will attract EU “state aid” approval.
Outline of Scheme Rules
- Throughout its relevant three-year qualifying period, the company must:
- Be an unquoted company (Note: The UK AIM market is “unquoted”)
- Be a trading company, carrying on a qualifying trade
- Exist for genuine commercial purposes, and not be part of a scheme for the avoidance of tax
- Not be a 51% subsidiary of another company, or otherwise under the control of another company
- The company must not be in “financial difficulty”
- The company need only have a permanent establishment in the UK (rather than as in prior years where it has had to have its business wholly or mainly carried on in the UK). Thus, there is an opportunity to use the UK EIS for non-UK operating companies (e.g. in the US or elsewhere).
- An investor cannot be ‘connected’ with the EIS company – i.e. broadly cannot own more than 30% of the shares/votes, directly or indirectly
- Individuals who are paid directors or employees of the EIS company at the time of the issue of shares are normally disqualified from claiming EIS relief. Otherwise, qualifying investors can, in certain circumstances, be paid for their work provided that the total remuneration package is reasonable
- The money raised by the EIS share issue must be wholly used for the qualifying business activity within a 2-year period
- Schemes that involve guarantees or exit arrangements will not attract tax relief.
Seed Enterprise Investment Scheme
To complement EIS, the Government announced in December 2011 the introduction of the Seed EnterpriseInvestment Scheme. It will be available from 6 April 2012 and will run alongside the existing EIS, but will be targeted at early stage companies carrying on, or preparing to carry on, a new business in a qualifying trade.
The main features of the Seed Enterprise Investment Scheme are:
- Income tax relief of 50% of the investment will be available to individuals who invest in qualifying companies, irrespective of their marginal rate of tax
- An annual investment limit of £100,000 per individual will apply
- A cumulative investment limit of £150,000 per company will apply
- Gains arising on the disposal of other assets in 2012/13 will attract a total capital gains tax exemption if they are re-invested through the SEIS in the same year
- The company must be less than 2 years old, with gross assets immediately before investment of no more than £200,000 and fewer than 25 full-time employees
- The funds raised must be for the purposes of a genuine new trading venture (although relief is not denied if the trade is never commenced) – making the relief particularly helpful for exploratory projects (e.g. film development or games/apps creation)
- Most of the EIS restrictions (e.g. unquoted, independence, no exit/guarantee arrangements) apply equally to SEIS.
The EIS scheme has gained particular popularity in the media sector – offering not only the upsides of income capital gains tax reliefs but also downside mitigation. EIS can be divided into those that are genuinely aiming to recap large returns for investors specialising in new entrepreneurial businesses and those playing as risk-free a strategy as possible to preserve capital and convert the 30% tax relief into a fixed return over the 3 year play. The UK government perceived that certain schemes lack substance and risk and have proposed tightening the rules from April 2012 so that only genuine small entrepreneurial businesses qualify rather than hive-outs from large existing businesses. Greater care will be needed in structuring schemes in the future, but the scheme will nevertheless continue to provide valuable resources to the UK media sector. The SEIS scheme will be an important tax relief (worth a maximum of 78% with the income tax and tax free holiday) attracting smaller investments into risky start-ups.
If you have any queries please contact Sue Crawford (T: +44 (0)1242 631228; E: email@example.com) or your usual contact at Wiggin LLP.