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EISy Does It - A Tax Shelter for the intrepid investor

EISy Does It - A Tax Shelter for the intrepid investor
The “Enterprise Investment Scheme” (EIS) is the latest incarnation of a series of schemes offering tax breaks to those prepared to invest in trading companies.

 

Its grandparent was the “Business Expansion Scheme” launched in the early 1980s. Like most schemes involving tax relief, the EIS has been tinkered with and amended in successive Finance Acts, and the detailed rules are extremely complicated, but the basic concept is simple.

 

The EIS offers tax breaks to individuals who subscribe for new shares in UK trading companies. In particular:

 

An income tax repayment of  20% of the amount invested, up to a limit of £400,000 investment per tax year (so a maximum repayment of £80,000)
Exemption from CGT when the shares are sold, provided they qualified for the income tax relief referred to above.

 

The ability to defer paying CGT on any other capital gains in the year, to the extent that the gain is reinvested in EIS shares – unlike the other two reliefs, there is no upper limit to the gain that can be deferred. When the EIS shares are sold, the old gain becomes chargeable again
 

EIS Companies

 

There are a number of rules that an EIS company must obey. Essentially, it must be a company trading in the UK, not a subsidiary of another company, not listed on the Stock Exchange and the trade it carries on must be a “qualifying business activity”.

 

There are also limits on the size of the company, so companies with substantial assets will not qualify.

 

“Qualifying Business Activity”

 

This is defined by exclusion, and the basic idea is to weed out trades that are too “safe” because, for example, they are backed by an investment in land. Hotels do not qualify (though, curiously, pubs and restaurants do) and nor does property development or farming.

 

There are other restrictions too, which I tend to think of as the “yuppie traps”. They date from the old BES scheme of the 1980s and prevent tax relief for investment in such “safe” things as fine wines and fine art.

 

There is no space here to go into the finer details, but HMRC do operate an informal clearance service in cases of doubt. The company can ask HMRC to confirm that its trade does or does not qualify for EIS status.

 

Quarantine Period

 

Most of the conditions for getting EIS relief apply for a period that begins one year before the investment is made, and continues until three years after the shares have been issued. This can lead to problems. I have seen too many cases where the company was so busy trading and expanding (or struggling and shrinking!) that it forgot the various rules it had to obey to avoid its shareholders getting their tax relief clawed back.

 

The “connection” Rule

 

In order to qualify for income tax relief (and thus the CGT exemption) the investor must not be “connected” with the company during the quarantine period.

 

The main way to become “connected” is if you (or you and your close relatives between you) own more than 30% of the company.

 

You will also be “connected” if you are made a director of the company, although there is a rather complicated exemption from this rule for so-called “business angels” who invest in companies they have not previously had anything to do with.

 

Note that this “connected” rule does not apply to the CGT deferral relief described above. You can be as “connected” as you like and still defer a capital gain, but you will not get the income tax repayment or the CGT exemption.

 

“Receiving value”

 

An EIS investor is not allowed to “receive value” from the company during the quarantine period. There are some exceptions to this rule, but in general it pays to be very careful not to take anything out of the company without checking with a tax adviser first.

 

Ask an Expert

 

If you are contemplating investing in a company and you think you might qualify for one or more of the EIS reliefs described above, talk to a tax adviser before you do anything else.

 

The fine detail of the EIS legislation is a minefield and it is all too easy to deny yourself the relief accidentally.

 

To take only one example, if you set up a new “off the shelf” company, you must generally get your EIS investors in and issue them with their shares before the company does anything else, and make sure that when you do issue the shares they are all issued together so that no-one gets his early and becomes “connected”, because for a brief period he has more than 30% of the shares that have been issued so far.

 

EIS in Practice

 

EIS companies range from those set up by a group of friends with a new business idea, to more formal enterprises set up by professional company promoters.

 

If you are considering setting up a company, or if you have an existing company and are looking to raise new finance by issuing more shares, it is always worthwhile checking to see if the company could qualify as an EIS company.