The Seed Enterprise Investment Scheme ( SEIS ) and the Enterprise Investment Scheme ( EIS )

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1 The Seed Enterprise Investment Scheme ( SEIS ) and the Enterprise Investment Scheme ( EIS ) Some Frequently Asked Questions The questions set out below are some that we are commonly asked in relation to SEIS and EIS. There are, however, numerous conditions for both schemes in relation to the investor, the shares issued and the investee company that must be met to enable an individual investor to claim SEIS or EIS relief. In some cases these conditions can continue to apply after the issue of the relevant shares, with tax relief clawed back if they cease to be met. We recommend that before any share issue in which SEIS or EIS monies are to be raised, the issuing company seeks specific advice regarding the conditions for relief and gives consideration to seeking an advance assurance from HMRC s Small Company Enterprise Centre (further details can be found at and Copies of our brochures providing more general detail around the benefits of SEIS and EIS investment, and the conditions applicable to obtaining relief, can be obtained via links on the following page: If you would like further information in relation to SEIS or EIS, please do not hesitate to contact us.

2 SEIS and EIS 1. Do shares need to be fully paid up in cash when they are issued? Shares must be paid up in cash as to their full nominal value and not issued in satisfaction of a debt due to the investor. In practice, this means it is advisable to ensure that cash is received by the company on or shortly before the issue of shares and that it is made clear that no debt is created in the process. In some cases it may be possible for the company to take funds from investors earlier, but specific advice should be sought in such circumstances. 2. Can EIS/SEIS relief be obtained on a conversion of loans or similar securities into shares? No. Relief is only available for cash subscriptions for shares. 3. What are the requirements for the shares issued? The shares must be subscribed for wholly in cash and (broadly) must be fully paid up at the time of issue (see questions 1 and 2 above). The shares must be ordinary shares and, broadly, they must not carry a present or future preferential right to dividends or to the company s assets on a winding up (and no present or future right to be redeemed). However, it is generally fine to include a preferential entitlement to proceeds of sale of the company. An ordinary share is a share which forms part of a company s ordinary share capital. Ordinary share capital means all the issued share capital of a company by whatever name called other than capital the holders of which have a right to a dividend at a fixed rate but no other right to share in the profits. 4. Can an investor benefit from anti-dilution protection against later funding rounds? Broadly, no. Relief is not available where the terms of issue of shares include any protection against the ordinary risks of investment (which would include protection against the company issuing shares at a later stage at a lower price). Care must also be taken where investors are to be given warrants or other rights to subscribe for shares in a later funding round, particularly where the strike price is discounted. Specific advice should always be sought in this regard. 5. Can SEIS or EIS shares be converted into deferred shares? One of the conditions for relief is that shares must be held for a 3 year period from the date of issue. If the original shares issued to certain persons (for example, directors) are converted into deferred shares if, say, certain performance targets are not met, then it would need to be considered whether, on a conversion, the investors will be treated as disposing of their original shares. In many cases if the shares were re-characterised from being ordinary shares to worthless deferred shares, this could amount to a disposal for SEIS or EIS purposes. On this basis, if the conversion took place within 3 years of the original shares being issued, relief may be wholly or partially withdrawn (depending on how many of the original shares have been converted to deferred shares). In some cases, however, there may be no withdrawal of relief, if for example the investor acts at arm s length and receives no value in exchange for the deferral of their shares. In such situations, the position would need to be carefully considered and we would generally recommend seeking an advance ruling from HMRC s Small Companies Enterprise Centre. 6. Can EIS/SEIS relief be obtained through an investment in an overseas company? For both EIS and SEIS purposes, the issuing company does not need to be incorporated in the UK but it must have a UK permanent establishment. A company will have a permanent establishment in the UK if (i) it has a fixed place of business in the UK through which the business of the company is wholly or partly carried on or (ii) an agent acting on behalf of the company has and habitually exercises in the UK authority to enter into contracts on behalf of the company. Monies raised by the share issue must be used for the purposes of a qualifying business activity which includes:

3 carrying on a new qualifying trade; preparing to carry on a new qualifying trade which the company begins to carry on within two years after the issue of the shares; or carrying on research and development, which must either be carried on when the shares are issued or be commenced immediately afterwards, and which the company intends should benefit or lead to a new qualifying trade. The qualifying business activity may be carried on either by the company issuing the shares or by a company which is a qualifying 90 per cent subsidiary of that company. The funds may be used by the overseas company itself, provided the UK permanent establishment criteria is met and the funds are used for a qualifying business activity. The conditions do not stipulate that the monies must be spent in the UK. 7. If a company incorporated in the UK receives EIS/SEIS investment, can the funds raised be used by an overseas subsidiary? The funds may be used by an overseas subsidiary, provided that they are used for a qualifying business activity and provided the subsidiary is a qualifying 90% subsidiary. However, the company actually issuing the shares must still meet the UK permanent establishment requirement (see question 6 above). 8. Can some of the monies raised under an SEIS or EIS investment be used other than for a qualifying business activity? An individual is only eligible for relief if the money raised by the issue of the shares is employed within a certain time and wholly for the purpose of the qualifying business activity for which it was raised. However, if an insignificant part of the money is employed for some other purpose, this is ignored. 9. Are there other ways for an investor to make a SEIS or EIS investment? Individuals can invest in qualifying companies directly or through a nominee or a suitable investment fund. Given the difficulties investors may have in identifying suitable companies in which to invest and the inherent risks arising from investing in smaller trading companies, some investors may wish to make investments through a fund (which can either be approved or unapproved by HMRC). SEIS and EIS funds are structured with a fund manager and a nominee company or custodian holding the shares in investee companies on behalf of the individual investors, thereby enabling investors to claim tax relief but with the benefit of having access to a managed portfolio of investments. Whilst EIS funds have become increasingly popular, specific SEIS funds have yet to gain traction. However, hybrid EIS/SEIS funds have gained in popularity which can offer investors access to both schemes. SEIS 10. At what stage can companies issue SEIS compliance certificates to investors? Companies cannot issue SEIS compliance certificates to investors unless they have either: a) spent at least 70 per cent of the monies raised in their qualifying business; or b) been actively trading for at least 4 months. Where a company is pre-trade or would not otherwise meet the second condition, it should, if possible, keep SEIS funds in a separate account (or at least ledger) and prioritise the utilisation of those funds for business expenditure ahead of other sources of funding. 11. Can a company issue SEIS qualifying shares after it has received EIS or VCT investment? No. SEIS qualifying shares cannot be issued if a company has already received EIS or VCT investment. 12. If the company was an off the shelf company, can this affect SEIS relief being available? The issuing company must not at any time in the period beginning with the date of incorporation and ending on the date 3 years after the issue of the SEIS shares be controlled by another company.

4 This requirement led to concerns that the purchase of an off the shelf company from a corporate provider could lead to this condition being failed. However, the condition has now been relaxed so that the issuing company can be an off the shelf company without this prejudicing the availability of SEIS relief. 13. Can a director or an employee claim SEIS relief? Directors A director of the investee company may be entitled to SEIS relief. However, caution must be exercised to ensure that where this is the intention, the entitlement to relief is not inadvertently failed. This could be because: Any individual (including directors) seeking relief must not have a substantial interest in the company at any time in the period commencing with the date of incorporation and ending three years after the date of the issue of the SEIS shares. A substantial interest is, broadly, a stake in the company which exceeds 30 per cent of the issued share capital, ordinary share capital or voting rights. An individual will not be treated as having a substantial interest in the company at a time when the company has not issued any shares other than subscriber shares and has not begun to carry on or prepared to carry on a trade or business. However, even if it is intended that a founder director who holds subscriber shares will hold 30 per cent or less, if there is a period in which other investors are subscribing for shares and that founder director s holding is not immediately diluted down to 30 per cent or less, then this condition will be breached. In determining whether an investor (including directors) has a substantial interest, shareholdings of associates are taken into account. Associates include, amongst other things, relatives, such as spouses, civil partners, parents, grandparents, children and grandchildren (but not brothers, sisters, cousins, aunts or uncles) and other business partners. This can limit the availability of SEIS relief where shares in the investee company are largely held by family members. Where it is intended that a director will hold 30 per cent or less of the company, care should be taken to ensure that shares are not issued to associates which when aggregated with the director s holding exceed 30 per cent of the company. Employees SEIS is not available to employees (or associates of employees) of the investee company or a qualifying subsidiary (broadly a 51% subsidiary of the investee company), unless the employee is also a director. 14. Can a founder claim SEIS relief? How about friends and relatives? As mentioned in question 13 above, an individual must not have a substantial interest in the company at any time between the date of incorporation to the third anniversary of the date of the issue of the SEIS shares. Founders will therefore generally fail this test, through holding in excess of 30% of the company s shares initially although this may not be the case in every situation (e.g. a new business founded by four unrelated individuals in equal shares could still allow SEIS relief for investment by one or more of those founders, provided their stakes remain below 30%). In addition, shareholdings of associates are taken into account when considering whether a person has a substantial interest. An associate is generally a spouse or civil partner, parent (or remoter antecedent) or child (or remoter forebear). As such, it may be more difficult for such persons to be able to claim SEIS relief as their shares will be aggregated with the founder s shares for the purposes of the 30 per cent test. Friends and remoter relatives (such as siblings, cousins, aunts and uncles) are not associates for these purposes. However, there are special rules to preclude relief where investments are connected with loans made to the investor (intended to prevent founders or other nonqualifying individuals lending money to friends or relatives who would in principle qualify for relief to fund their investment). 15. Can SEIS relief be obtained for a company that would not otherwise qualify (e.g. if part of its business is demerged or spun out of the company)?

5 No. The SEIS regime includes rules to prevent structures that circumvent the core requirement that the company raising the capital must be a genuine start-up. These rules also extend to trigger a withdrawal of tax reliefs if the issuing company subsequently acquires a business or company with which the investors have previously been involved or connected. Specific advice should always be sought in any such situations. 16. Can a company that has carried on an earlier trade before the current activity issue shares under SEIS? No. The regime requires that the company s current trade commenced no earlier than two years before the shares were issued and that the company has carried on no previous trade. This means that if a founder has a company that had previously carried on a trade that subsequently ceased, that company should NOT be used to start a new venture if SEIS relief is desired for investors. 17. Is SEIS relief lost following a subdivision of shares? Provided the shares are simply subdivided so that the nominal value of each share is reduced, this should not impact on an investor s entitlement to SEIS relief. It is the rights attaching to the shares which are important for SEIS purposes, so in the event these rights are affected SEIS relief may be lost. EIS 18. Can a company issue EIS qualifying shares after SEIS qualifying shares have been issued? The issuing company is limited to raising a maximum of 150,000 through SEIS investment in its lifetime. The issuing company is however then able to seek EIS (or VCT investment) but only if at least 70 per cent of all monies raised under SEIS (at any time) have been spent in the company s qualifying business activities. If a company is seeking to raise in excess of 150,000 through the tax advantaged venture capital schemes, it must complete the SEIS qualifying share issue and spend at least 70 per cent of the monies (and be able to demonstrate this) before issuing any shares under EIS or VCT. The following question expands on this. 19. What happens if a company wants to raise more than 150,000 and investors expect to benefit from both SEIS and EIS relief? EIS shares cannot be issued until at least 70% of any SEIS monies raised have been spent by the company in its qualifying business. However, HMRC accept in their published guidance that a company is not precluded from raising over 150,000 in one exercise and issuing shares under EIS in respect of the excess over 150,000 at a later stage. It is, however, important to ensure that no debt is created between the company and the investor(s) in respect of the excess, so (for example) there should be no right for the investors to require repayment of the excess pending issue of the EIS shares. In such situations, we would recommend specific advice be sought and we would generally recommend seeking an advance ruling from HMRC s Small Companies Enterprise Centre. Key Contacts Robert Young Partner, London +44 (0) r.young@taylorwessing.com Neil McKnight Senior Associate, London +44 (0) n.mcknight@taylorwessing.com James Stewart Associate, London +44 (0) j.stewart@taylorwessing.com Europe > Middle East > Asia Taylor Wessing LLP 2013 This publication is intended for general public guidance and to highlight issues. It is not intended to apply to specific circumstances or to constitute legal advice. Taylor Wessing s international offices operate as one firm but are established as distinct legal entities. For further information about our offices and the regulatory regimes that apply to them, please refer to: NB_001292_11.13