www.pwc.co.uk A brief guide to the Enterprise Investment Scheme Updated to Finance Act 2013 This document is for general guidance only. Action should not be taken without obtaining specific advice July 2013
Contents Benefits of EIS investment 1 1. Introduction 2 2. The reliefs 3 3. Main aspects and conditions of the reliefs 6 4. The individual investor 8 5. Subscription for eligible shares in a qualifying company 9 6. Qualifying trade and business activity 12 7. Claiming the reliefs 14 8. Withdrawal of reliefs 15 9. Interaction with CGT rates, taper relief and entrepreneurs relief 17 10. Prevention of avoidance 19 11. Conclusion 20 12. Further information 21 Updated to Finance Act 2013 PwC Contents
Benefits of EIS investment Main tax reliefs arising from subscription for shares in a qualifying EIS company There are four main reliefs available, subject to meeting the various conditions applicable to the company, its trade and its shares and to the individual: Income tax relief @30% on amounts subscribed up to a maximum of 1m in a tax year; Unlimited capital gains deferral; Capital gains tax free disposal for shares which attracted income tax relief; Income tax or capital gains tax loss relief for losses on disposal. In addition: Potential Business Property Relief for Inheritance Tax purposes once shares have been held for a minimum of two years; Business Investment Relief may be available for non-domiciled investors. Updated to Finance Act 2013 PwC 1
1. Introduction The Enterprise Investment Scheme ( EIS ) was established by the 1994 Finance Act for shares issued on or after 1 January 1994. It replaced the Business Expansion Scheme. Both were designed to stimulate investment in unquoted companies. In the following year, Finance Act 1995 introduced capital gains provisions offering a tax deferral where gains on disposals of any assets arose on or after 29 November 1994. Investment in unquoted trading companies often carries a high risk and the tax relief is intended to offer some compensation for that risk. The EIS offers both income tax and capital gains tax ( CGT ) reliefs to investors who subscribe for shares in qualifying companies. As part of that it offers a subsidised source of equity funds to companies for which borrowing might be expensive, or impossible because of a lack of security. The EIS is subject to the requirements of the EU State Aid for Risk Capital Guidelines. A number of changes and restrictions have been introduced by Finance Acts in the period 2006 to 2012 with a view to making the EIS compliant with the Guidelines. EU State Aid Approval was most recently received on 31 May 2012. This guide gives a brief outline of the key aspects of the reliefs for investors who seek income tax relief and/or deferral of CGT by reinvestment of gains through a subscription for shares in an EIS qualifying company. The main opportunity for deferral of CGT is now through the EIS and thus it is an important source of tax relief. The qualifying conditions for EIS companies described in this booklet are also used as a basis for designing the qualifying conditions for companies under the Seed Enterprise Investment Scheme ( SEIS ) and the Enterprise Management Incentive Scheme ( EMI ) as well as for Venture Capital Trust ( VCT ) investee companies. As a result, there are a number of opportunities for tax efficient funding for companies which meet the qualifying conditions. The qualifying conditions are also similar to those for investments qualifying for the Business Investment Relief under the rules applicable to non-domiciled individuals making remittances to the UK. Generally the EIS rules are more restrictive, so many investments which qualify under the EIS should qualify for Business Investment Relief ( BIR ), but those seeking BIR should confirm that direct with their Inspector of Taxes before investing. It is possible that some EIS qualifying companies may also meet the conditions to be qualifying investments for the purpose of obtaining a Tier 1 visa, but again, any would-be investors should check that themselves before investing. Investors may also be able to claim Business Property Relief for Inheritance Tax purposes once the EISqualifying shares have been held for at least 2 years. However, the EIS legislation is complex and contains many traps for the unwary. Investors and companies should not therefore take any action without obtaining specific professional advice. Updated to Finance Act 2013 PwC 2
2. The reliefs EIS income tax relief For the 2012/13 tax year onwards, income tax relief is available at a maximum rate of 30% in respect of a subscription of up to 1,000,000 in any tax year, i.e. a maximum of 300,000 of income tax relief. The rate of relief prior to 6 April 2011 was 20%. An investor may elect to carry back to the previous tax year the amount he subscribes after 5 April 2009 for eligible shares in a tax year, subject to the applicable annual limit, which is 1,000,000 for 2012/13, and his income tax liability for the year. Relief will be given at the rate applicable to that previous year so a claim to carry back a subscription made in 2011/12 to 2010/11 would result in income tax relief at 20% on a maximum of 500,000. Capital gains tax reliefs The reliefs from capital gains tax available for shares where income tax relief has been claimed takes two forms. On investment: An investor may claim to defer capital gains up to the amount of his investment more detail is given below. On disposal: If the conditions for EIS income tax relief have been met, any gain (other than a deferred gain) on the first disposal of EIS shares is not chargeable to capital gains tax. If there is a loss, capital gains tax relief is available as an alternative to the income tax relief mentioned above. Deferral relief Deferral relief is available for gains arising on the disposal of any asset on or after 29 November 1994 (but see time limit for claims). It is obtained by reinvesting part or all of the gain (before taper relief for gains after 5 April 1998 and prior to 6 April 2008) by subscribing for shares in an EIS qualifying company. On making a claim, the relief will be given as a deferral of the chargeable gain, by matching it with a subscription for eligible shares. As a result, the capital gain is deferred until these new shares are disposed of, or in some cases, until the happening of an event which causes the relief to be withdrawn a chargeable event. Where appropriate, a claim for relief may be made in a reduced amount in order to utilise the benefit of other reliefs, for example allowable losses and the annual exemption. CGT deferral relief cannot be claimed on gains that arise after 22 June 2010 where Entrepreneurs Relief is claimed (see Section 9). The EIS investment must be made in the period which commences one year before and ends 3 years after the capital gain. HM Revenue & Customs have discretion to extend this period in certain circumstances. Deferral relief is available only where a gain arises on an actual disposal of an asset or on a clawback of relief given on an earlier investment under the EIS, reinvestment relief or VCT provisions. Relief is not, therefore, available to an individual in respect of a capital gain which is realised by the trustees of a settlement, but which is deemed to be that individual s gain because he is the settlor or a beneficiary of the settlement. Where, however, the settlement is resident in the UK the trustees may be able to defer the gain by making a qualifying reinvestment. Updated to Finance Act 2013 PwC 3
Income tax loss relief Further income tax relief may be obtained if there is a loss on ultimate disposal of shares which obtained and retained EIS income tax relief. Thus if an investor were to lose the total amount invested, they might obtain income tax relief of up to 61.5% of their loss at a time when their top rate of income tax is 45%. The provisions relating to tax relief against income for losses on shares in unquoted trading companies permit a claim for the year of loss or the previous year thus if a loss arose in 2014/15, a claim could be made for loss relief in 2013/14 and 2014/15 up to the amount of the loss or until the restriction came into effect because the losses exceed the restricted amount. There may be a restricted amount of income tax relief available for a loss on disposal of shares for which Deferral Relief only was claimed. The Finance Act 2013 has introduced with effect from 6 April 2013 for the tax year 2013/14 and subsequent tax years, restrictions on the amount of income tax reliefs including for losses on disposal of shares in unquoted trading companies. Those restrictions will apply to losses arising on the disposal of shares where Deferral Relief only has been claimed. (There is a carve out for shares where EIS income tax relief has been claimed and retained.) The limit on the total income tax relief within the restricted categories (including for losses) in any year will be 50,000 or if greater 25% of the taxpayer s adjusted total income for the year. Updated to Finance Act 2013 PwC 4
Example of income tax relief and deferral relief Mr Jones makes a capital gain of 250,000 on 3 July 2012 on the sale of an investment property which he had acquired in January 2004. On 3 October 2012 he subscribes 225,000 for 20% of the ordinary shares in Initiative Limited, an unquoted trading company manufacturing engine parts. Initiative Limited is a qualifying company for EIS purposes and Mr Jones claims EIS relief. His taxable income in 2012/13 was 150,000 and in 2013/14 is expected to be 300,000 so he pays income tax at a rate of 45% on the majority of his income in 2013/14. He had made no other EIS investment during 2012/13. Mr. Jones tax saving as a result of his EIS investment is: Income tax 2012/13 225,000 @ 30% 67,500 Capital gains tax deferred 2012/13 225,000 @ 28% 63,000 Total tax saving and deferral on 225,000 invested i.e. @ 58% 130,500 If Mr Jones and Initiative Ltd continue to meet the qualifying conditions for EIS income tax relief purposes until 3 October 2015, Mr Jones will be able to sell his shares in Initiative Ltd with no liability to capital gains tax on any profit which arises on those shares. The deferred gain of 225,000 will become chargeable at the rate of capital gains tax prevailing when he disposes of his shares in Initiative Ltd which based on current legislation will be 28%. He has until 31 January 2019 to claim the relief, being the 31 January which falls five years after the 31 January next following the end of the year of assessment in which the investment was made. In order for Mr Jones to claim relief, Initiative Ltd must first put in a claim relating to its qualifying status on form EIS 1 by 5 April 2015, being 2 years after the end of the year of assessment when the shares were issued. It will then receive a form EIS 3 from HM Revenue & Customs to pass to Mr Jones to use to claim his relief. For more details on claiming the relief, please refer to Section 7. If the gain realised by Mr Jones had qualified for entrepreneur s relief, he would have needed to choose whether to claim deferral relief or entrepreneurs relief. A claim for deferral relief in respect of a gain arising after 22 June 2010 precludes a claim for entrepreneurs relief. Entrepreneur s relief reduces the CGT rate to 10%, but a claim for deferral relief could increase the tax rate when the gain falls back into charge to 28% at the current rate of CGT for a higher rate taxpayer. Example of deferral relief only An investor makes a capital gain in May 2013 on the sale of shares in a quoted company for 1,500,000 which he purchased for 1,000,000 in April 2000. The capital gain after costs is 450,000. In July 2013 he subscribes 400,000 for shares in a qualifying EIS company. However, he has not used his annual CGT exemption of 10,900 for 2013/14 and has capital losses brought forward of 50,000, so he only needs to claim deferral relief of 389,100 in order to reduce his taxable gains for the year to nil and utilise his annual exemption. This deferred gain will become chargeable on disposal of the EIS shares at the prevailing rate of capital gains tax at the time of disposal which under current legislation will be 28% for a higher rate taxpayer. Updated to Finance Act 2013 PwC 5
3. Main aspects and conditions of the reliefs In the text which follows we describe the conditions applicable to both EIS Income Tax and CGT Deferral Relief, and then the conditions which apply specifically to one or the other. Conditions relating to EIS income tax and EIS deferral relief The investor must be an individual who subscribes in cash for new shares in a qualifying company. The investment may be made by direct subscription, by a nominee or through an EIS Fund. Trustees of certain settlements may obtain CGT deferral relief only. The maximum amount a company may receive in a 12 month period from EIS or certain other state aid supported sources is 5m (see Section 5). A gross assets test applies to determine whether a company qualifies for EIS purposes. See section 5 The reliefs may be denied initially or clawed back if either the investor or the investee company do not meet certain requirements during specified periods of time described as the relevant period in this guide. The relevant period ends three years after the issue of the shares or, in the case of a company not trading when the shares are issued, three years from commencement of trade. There are four different times when the relevant period may begin, depending on the condition to be met. These are:- 1. two years before the issue of the shares; 2. incorporation of the company if later than (1); 3. one year before the issue of the shares; and 4. the date of issue of the shares. The commencement time applicable in each of the above is described in the relevant section of this booklet. Certain arrangements for realisation of the investment will prevent the shares from attracting relief. A claim for relief must be made by both the company and the investor within specified time limits (see Section 7). EIS income tax relief specific The maximum amount for which an individual may obtain income tax relief in any tax year commencing after 5 April 2012 is 1m. This limit was 500,000 for the years 2008/9 to 2011/12, 400,000 for 2006/7 and 2007/8 and 200,000 for 2004/5 and 2005/6. Up to 5 April 2012, the minimum amount an investor could invest in any one company in any year and obtain income tax relief was 500; this minimum limit was removed for the 2012/13 tax year and going forward. There are specific requirements which apply to the individual and their relationship with the company, which affect the availability of EIS income tax relief they are described in Section 4 below. Updated to Finance Act 2013 PwC 6
Deferral relief specific The investor must be a UK resident individual who subscribes in cash for new shares in a qualifying company. The investment may be made by direct subscription, by a nominee or through an EIS Fund. The trustees of most UK settlements may also be eligible to claim obtain CGT deferral relief. Deferral relief can be used to defer capital gains which arise on disposals of assets of any description. Reinvestment of a gain must normally be made within the period which begins one year before and ends three years after the disposal which produced the gain in respect of which relief is claimed. Updated to Finance Act 2013 PwC 7
4. The individual investor EIS Income tax relief If an individual is to obtain and retain EIS income tax relief and have a capital gains tax free disposal in respect of his investment in a company he must: Subscribe for eligible shares on his own behalf, although such subscription may be made via a nominee; Continue to hold the shares until three years after subscription or three years after commencement of trade if later; Not be connected with the company at any time in a period of restriction. This period commences 2 years before the issue of shares or, if later, with incorporation of the company. The period ends three years after the subscription for shares, or, if later, three years from commencement of trade. Broadly an individual is or becomes connected with the company if he or an associate (broadly a spouse, lineal relative or member of the same partnership): Is an employee of the company which issues the shares or of any subsidiary of the company; Is a paid director other than a business angel; Owns or has voting control over more than 30% of the company s share capital. For shares issued prior to 6 April 2012, there is an additional test of whether the subscriber possessed more than 30% of the combined share and loan capital; Would be entitled on the winding up of the company, or in any other circumstances, to more than 30% of the assets of the company or any subsidiary available for distribution to the holders of ordinary shares or loan creditors who have made a loan other than a normal commercial loan. In considering this 30% test, loans which are not normal commercial loans made by the investor to the company can have a significant effect and it is generally unwise for an EIS investor to loan money to the company in which he holds shares on terms which are not normal commercial terms. The main factors which identify a loan not on normal commercial terms are a conversion right, a right to acquire shares, interest other than at a fixed rate or in excess of a commercial amount. The repayment of any type of loan may be treated as value received (see Section 8) and in general loans from investors to a company in which they have shares intended to qualify for EIS Income Tax or Deferral Relief are not recommended it would often be preferable for the investor to guarantee a bank overdraft. The concept of a business angel within the EIS provisions is an important one for both the individual and the company. A business angel is an individual previously unconnected with the company, or its trade, who subscribes for shares and is then appointed a director entitled to receive reasonable remuneration for his services to the company. This offers an individual the opportunity to be involved with the company in which he invests with the possibility of a tax free capital gain, and the company the potential opportunity to attract both management skill and investment monies. Deferral relief Investors eligible to claim deferral relief are individuals and trustees of certain settlements. Broadly, trustees of discretionary trusts should be able to claim deferral relief, if all the beneficiaries are individuals, and trustees of interest in possession trusts may claim if any of the beneficiaries are individuals. The investor must be resident and ordinarily resident in the UK both at the time the gain accrues and when he makes the subscription for shares in respect of which deferral relief is claimed. The connection tests described above which apply to an investor for the purpose of a claim for income tax relief under the EIS do not apply where the relief claimed is capital gains deferral only. Thus for instance an individual may control a company and obtain deferral relief only under the EIS for his subscription. Updated to Finance Act 2013 PwC 8
5. Subscription for eligible shares in a qualifying company There are a number of conditions and requirements to be met if a company is to be a qualifying company which issues eligible shares which are described below. These apply to claims for income tax relief and deferral relief. Conditions relating to shares Eligible shares are new ordinary shares which carry no prohibited preferential rights to dividends or any preferential rights to assets on a winding up and are not redeemable. A right is preferential with regard to dividends if the amount or date of payment of the preferential right may be determined to any extent by the company, the holder of the share or any other person. The shares must meet these conditions for the relevant period described below. The tax reliefs are given to encourage risk investment, and so there are provisions whereby shares issued will not qualify for EIS relief if there are specified arrangements in place when the shares are issued, which might provide a measure of protection to investors. These include arrangements for: Subsequent repurchase or disposal of the shares; Cessation of the trade; The disposal of the company s assets; and Providing protection from risk for investors, other than normal commercial protection arrangements. Arrangements are broadly defined and include those which are not legally enforceable. HM Revenue & Customs take the view that anti-dilution clauses and conversion rights are prohibited by this legislation. Conditions relating to the company The control and independence and activity requirements If a company is to be a qualifying company for EIS purposes it must, throughout its relevant period : Not be under the control of another company or control another company other than a qualifying subsidiary; Carry on a qualifying activity (see Section 6 below) or be the parent company of a group of companies the business of which consists of qualifying activities; and No other person may carry on the qualifying activity, and therefore companies which carry on their trade through a partnership will not meet the qualifying conditions. The relevant period commences with the issue of the EIS shares and ends on the third anniversary, or, if later, three years after the trade commences. Updated to Finance Act 2013 PwC 9
Requirements relating to subsidiaries In general terms a qualifying subsidiary is one which is more than 50% held (i.e. the majority of its issued share capital must be owned, directly or indirectly, by the issuing company) and is not under the control of another company. When the company which applies the funds raised is a subsidiary of the issuing company, it must be a qualifying 90% subsidiary. It can be a directly owned subsidiary in which at least 90% of the shares are held, or a subsidiary which is a 100% subsidiary of a direct 90% subsidiary of the parent, or a 90% subsidiary of a 100% subsidiary of the parent. Thus monies may be applied by subsidiaries two tiers down in a group; for shares issued prior to 6 April 2007 monies could only be applied by a directly held 90% subsidiary. Any group property management company must also be a qualifying 90% subsidiary of the issuing company as described above. The Unquoted requirement At the time the shares are issued, the company must be unquoted and there must be no arrangements in place for it to cease to be unquoted. The definition of unquoted permits companies whose shares are quoted on the Alternative Investment Market ( AIM ) at the time they are issued to qualify. The Gross assets requirement The company may not have gross assets of more than 15m immediately before it receives a subscription for eligible shares or more than 16m immediately after. For shares issued after 5 April 2006 and prior to 6 April 2012 these limits were 7m and 8m respectively. The number of employees requirement For shares issued on or after 6 April 2012, investee companies or groups must have fewer than 250 fulltime employees (or the full-time equivalent) at the date of issue of shares to EIS investors. For shares issued on or after 19 July 2007 and before 6 April 2012 this limit was 50. The maximum amount raised annually through risk capital schemes requirement For shares issued on or after 6 April 2012, an investee company may receive not more than 5 million from EIS investors (or from a mixture of EIS and Venture Capital Trust investors) in a 12 month period. Also included within the 5m limit is any investment made in the company from a source regarded as EU State Aid within a definition. Prior to 6 April 2012 the limit was 2m and investment from EU State Aid sources was not included. If the limit is exceeded, none of the shares or securities within the issue that causes the condition to be breached will qualify. The financial health requirement For shares issued on or after 6 April 2011, a company which is regarded as an enterprise in difficulty under the EU Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty (2004/C244/02) is not eligible to receive funding under the EIS. The UK permanent establishment requirement For shares issued on or after 6 April 2011, the company which issues shares to investors wishing to claim tax reliefs under the EIS is required to have a permanent establishment in the UK. The no disqualifying arrangements requirement An important new amendment to the legislation of wide-reaching effect came into effect for shares issued on or after 6 April 2012 which is the No disqualifying arrangements requirement. It is described in more detail in Section 10 Prevention of Avoidance. Updated to Finance Act 2013 PwC 10
The spending of money raised by the SEIS requirement A company which qualifies under the EIS may already have raised money and qualified under the SEIS. If this is the case, it must have spent at least 70% of the monies raised under the issue of shares to SEIS investors, before it may issue shares which qualify under the EIS. Updated to Finance Act 2013 PwC 11
6. Qualifying trade and business activity In general, most trading companies will be regarded as carrying on a qualifying trade and business activity for EIS purposes, if the trade (or trades) is conducted with a view to a profit and do not to any substantial extent (for this purpose greater than 20%) include any of the following activities: Dealing in land, in commodities or futures, or in shares, securities or other financial instruments; Dealing in goods otherwise than in the course of an ordinary trade of whole or retail distribution. There are specific rules about dealing in goods to ensure that relief is available only where the company s trade is genuine, and not a disguised investment activity; Banking, insurance, money lending, debt factoring, hire purchase financing or other financial activities; Most leasing activities and some letting of ships on charter; Receiving royalties or licence fees, except royalties or licence fees resulting from the exploitation of particular intangible assets described below; Providing legal or accountancy services; Property development; Farming or market gardening, forestry and timber production; Operating or managing hotels or guest houses, nursing or residential care homes; and, for shares issues on or after 6 April 2008; Coal production; Steel production; and Shipbuilding; and, for shares issued on or after 23 March 2011, subject to provisions for shares issued before 6 April 2012; Subsidised generation or export of electricity. The restrictions on companies whose activities consist wholly or to a substantial extent of the subsidised generation of electricity apply to wind or solar power which gives rise to Feed-In Tariff ( FiTs ) (or equivalent) income. Thus the receipt of FiTs in respect of the generation of electricity as a result of anaerobic digestion process or from a hydroelectric plant remains a qualifying activity for shares issued on or after 23 March 2011. Companies which issued shares on or after 23 March 2011 but which commenced a trade of subsidised generation of electricity giving rise to FiTs from solar or wind power will still qualify under transitional provisions provided they commenced that trade before 6 April 2012. For investments prior to 6 April 2011, the qualifying activity had to be carried on wholly or mainly in the UK. For investments on or after 6 April 2011, the company issuing shares to the EIS investors must have a permanent establishment in the UK. Updated to Finance Act 2013 PwC 12
Royalties and licence fees The EIS legislation defines certain types of intangible assets from which royalties and licence fees may be received without prejudice to the company s qualifying status. Broadly, the intangible asset (or at least the greater part of its value) must result from the company s own research and development work. Research and development from which it is intended a qualifying trade will be derived may of itself be a qualifying business activity. Intangible assets for this purpose are assets treated as such under normal accounting practice. Where the intangible asset is intellectual property the right to exploit it must rest with the company. Intellectual property means any patent, trade mark, registered design, copyright, design right, performer s right or plant breeder s right. This exemption for receipt of royalties and licence fees is important as certain technology companies might not otherwise qualify under the EIS. Application of funds and commencement of trade The funds raised under the EIS must be applied by the company to the qualifying activity within two years of subscription or, if later, commencement of the activity. Commencement of trade must occur within 2 years of the share issue. For shares issued on or after 6 April 2012, the employment of the monies in the acquisition of shares in a company is not of itself regarded as employing them for the purpose of a qualifying business activity. Updated to Finance Act 2013 PwC 13
7. Claiming the reliefs HM Revenue & Customs offer a very valuable non-statutory service to companies wishing to raise funds from investors who wish to claim EIS relief in respect of their investment. Such companies may supply certain specified details about themselves, their trade and their shares to HMRC and HMRC will confirm whether the company will be a qualifying company for EIS purposes, prior to the issue of the shares this confirmation is known as an advance assurance. HMRC will not confirm whether a specific individual will qualify for the tax reliefs. However, provided subscribers meet the conditions applicable to them, they may subscribe with the comfort that provided the company does what it told HMRC it would do, and subject to satisfactory completion of form EIS 1, HMRC is bound by the advance assurance it has given and the EIS relief will be available for qualifying investors. We almost always recommend that companies should seek an advance assurance where investors are hoping to obtain tax reliefs under the EIS and the existence of the advance assurance does make it easier for companies to raise monies from investors for whom the tax relief is a requirement. Once the shares have been issued, here are two stages to the claim for relief. Initially the company must make a claim that it is a qualifying company. Once this is established, the individual investors may claim relief. The company makes its claim using form EIS1. The formal claim by the company for relief cannot be made until the company has carried on the qualifying trade (or research and development) for at least four months. The claim must be made within two years after the end of the tax year in which the subscription for shares was made, or, if later, two years after the end of the period of four months of trading mentioned above. Once HM Revenue & Customs is satisfied that everything is in order with the information on the form EIS1, form EIS2 will be issued to the company. This authorises the company to issue form EIS3 to the investors. Once the investors have forms EIS3, they may make the relevant claims in their self assessment tax returns. The claim must be made not later than the fifth anniversary of 31 January following the year of assessment for which the relief is claimed. If the investor does not hold form EIS 3 he may not claim to defer payment of tax because of his EIS investment. This can cause particular difficulties for investors claiming deferral relief, because until they have form EIS 3 they have to fund both the share subscription on the new investment and the tax which arises on the shares disposed of. If form EIS3 is received during the year of assessment for which the relief is claimed, investors may apply to HM Revenue & Customs to adjust their PAYE code, or to amend their payments on account if appropriate. Updated to Finance Act 2013 PwC 14
8. Withdrawal of reliefs EIS income tax reliefs Income tax relief may be withdrawn if within a specified period: The company ceases to be a qualifying company (see Section 5); The investor ceases to be a qualifying individual (see Section 4); The shares cease to be eligible shares (see Section 5); The investor disposes of his shares other than to a spouse or to a new company which issues its own shares in exchange; or There is a significant receipt of value which is not returned (see below). The specified period is one which commences with the issue of the shares and ends after three years, or if later, three years from commencement of trade by the company. Relief may also be withdrawn if the company does not apply the funds raised and commence to trade within the timescale set out in section 6 above. Relief is withdrawn by means of an assessment to recover the income tax payable and interest may be charged from the date the relief was originally given, or the date of the disqualifying event. Deferral relief A gain which has been deferred will fall into charge to CGT if within the period specified above: The company ceases to be a qualifying company (see Section 5); The shares cease to be eligible shares (see Section 5); The investor becomes non-resident, otherwise than for an employment all the duties of which are outside the UK and in which he will become resident again within 3 years, still owning the shares; or There is a significant receipt of value which is not returned (see below). Deferral relief will also be withdrawn if: The funds raised have not been applied for the purpose of the qualifying activity within two years of the share issue or two years of the commencement of trade, if later. Commencement of trade must occur within two years of the share issue; or The investor disposes of his shares at any time other than to a spouse or to a new company which issues its own shares in exchange. A chargeable gain will arise at the time of the event which causes the relief to be withdrawn. Updated to Finance Act 2013 PwC 15
Receipt of value Income tax relief If the investor receives significant value from the company which is not returned, income tax relief will be withdrawn to the extent of the income tax relief attributable to the amount of the value received, or in full if the value received exceeds the original investment. The income tax relief available would be restricted initially if any value had been received in the period commencing one year before the issue of shares. The capital gains tax free disposal is also rateably restricted where there has been a receipt of value. Deferral relief If the investor receives significant value from the company, deferral relief will be withdrawn in full unless the value received is returned. No deferral relief is available if the investor received significant value in the year prior to the issue of shares unless the value is replaced. Nature of value received Receipt of value can include any payment made or benefit provided by the company to the investor or an associate other than a payment which represents reasonable remuneration, return on investment or payment for goods or services provided. Redemption of shares or securities, or a loan repayment can be value received. Where value is received by an investor, he has the opportunity to repay that value as soon as is reasonably practicable and preserve his tax reliefs. Depending on the circumstances in which the value is received, it may not be regarded as significant if it is less than 1,000 or, if greater, is insignificant in relation to the amount subscribed; the test of relative insignificance will not in most cases result in an amount greater than 1,000 being accepted as insignificant by HM Revenue & Customs. The reliefs available to an investor will also be affected if other investors receive significant value from the company in the period which applies for receipt of value by the investor; value in such circumstances includes the redemption or repurchase of shares or a payment for giving up rights to shares. Updated to Finance Act 2013 PwC 16
9. Interaction with CGT rates, taper relief and entrepreneurs relief Taper relief The interaction of deferral relief and taper relief with the 18% rate of CGT from 6 April 2008, and the 18% and 28% rates after 22 June 2010, should be reviewed to make sure the situation is understood in respect of gains which arose prior to 6 April 2008. Taper relief was abolished with effect from 6 April 2008. Prior to that, EIS deferral relief was applied before taper relief and the taper relief is given when the deferred gain subsequently falls back into charge to capital gains tax, which now will only occur on the disposal of the shares other than to a spouse or civil partner with whom the transferee is living. Gains which arose after 5 April 2008 do not attract taper relief when they fall back into charge to capital gains tax and are subject to the prevailing rate of capital gains tax. The prevailing rate is currently 18% (or 28% for a higher rate taxpayer), or 10% where entrepreneurs relief is available. Although there can be a cash flow advantage to making a claim for deferral relief under the EIS, there may be an absolute cost depending on the taxpayer s situation with the changes to CGT. Example of tax reliefs Mr Smith makes a capital gain of 250,000 on 3 July 2012 on the sale of an investment property which he had acquired in January 2004. On 3 October 2013 he subscribes 225,000 for 40% of the ordinary shares in Trading Company Limited, an unquoted trading company which sells children s clothing. Trading Company Limited is a qualifying company for EIS purposes and Mr Smith claims EIS deferral relief. Mr. Smith s CGT saving as a result of his EIS investment is: Capital gains tax deferred 2012/13 225,000 @ 28% 63,000 Mr Smith and Trading Company Ltd continue to meet the qualifying conditions for EIS purposes until 3 October 2016 when he sells his shares in Trading Company Ltd. Any gain on those shares will, under current legislation, be chargeable at 28% since Mr Smith is a higher rate taxpayer (or 10% if he is able to claim entrepreneurs relief). The deferred gain of 225,000 will also become chargeable at the rate of capital gains tax prevailing when he disposes of his shares in Trading Company Ltd which, based on current legislation, will also be 28%. NB If Mr Smith had been a basic rate taxpayer in 2012/13 and his gain had been only 10,000 all of which fell within his basic rate band bearing tax @18%, he would need to consider the risk that if he deferred the gain it might fall back into charge at 28% if he were liable to higher rate tax at that time. As a result of the claim he would ultimately incur an additional capital gains tax liability of 1,000. Updated to Finance Act 2013 PwC 17
Entrepreneurs relief Finance Act 2008 introduced a new relief (Entrepreneurs Relief) which can apply where an individual or trustee disposes of certain qualifying business assets after 5 April 2008. When introduced, the relief allowed the first 1 million of lifetime capital gains arising on such qualifying disposals to be charged to CGT at an effective rate of 10%. The lifetime limit was increased to 2 million for gains arising after 5 April 2010, to 5 million for gains arising after 22 June 2010 and to 10 million for disposals on or after 6 April 2011. Entrepreneurs relief gains after 22 June 2010 The 10% entrepreneurs relief rate will not be available for a gain which arose on or after 23 June 2010 where deferral relief is claimed and the gain then falls back into charge to capital gains tax. The investor has to decide whether:- to claim Entrepreneurs Relief in respect of the gain and pay the capital gains tax at 10% rate on the normal due date; or to claim EIS Deferral Relief and pay tax at the prevailing rate when the gain falls back into charge to capital gains tax, which at present would be 18% or 28%. Entrepreneurs relief will not be available for the deferred gain. Entrepreneurs relief gains before 6 April 2008 There is transitional relief which can apply where a gain which arose to an individual before 6 April 2008 has been deferred by investment in qualifying EIS shares and there is a chargeable event in relation to those EIS shares after 5 April 2008. Subject to a claim by the individual taxpayer, this transitional relief will apply to the deferred gain which crystallises on the chargeable event, provided the original gain which arose before 6 April 2008 and was deferred, would have qualified for entrepreneurs relief had that relief been in force at that time. Updated to Finance Act 2013 PwC 18
10. Prevention of avoidance There are further wide ranging and complex provisions which can apply to deny the availability of relief or to claw back relief which has already been given. For EIS Income Tax Relief, these include provisions relating to reciprocal arrangements and replacement capital. For both EIS Income Tax Relief and Deferral Relief there is a general provision denying relief where the motive is tax avoidance. A loan raised specifically to acquire EIS or Deferral Relief shares may, depending upon its terms, prevent relief being available. The no disqualifying arrangements requirement A new requirement was introduced with effect from 6 April 2012 which we describe in this section the No disqualifying arrangements requirement. This was introduced to prevent the EIS and Deferral Relief being used to deliver a tax mitigation product to investors where the company or companies involved are regarded as having little or no other commercial purpose, or of delivering the benefits of EIS tax-advantaged finance to another entity or project which would not itself qualify for support under the schemes. The intention is to disqualify companies which would have been unlikely to exist in the first place, or would have been unlikely to carry on the particular activities in question, were it not for the wish to achieve one 0r both of the purposes described. Shares must not be issued, nor any money raised by the issue employed, in consequence of or in connection with disqualifying arrangements. Arrangements are disqualifying arrangements If the main purpose, or one of the main purposes, of the arrangements is to secure: i. That a qualifying business activity (the one for which the money is raised) is or will be carried on by the issuing company, or a qualifying 90% subsidiary of that company, and ii. That one or more persons (whether or not including any party to the arrangements) may obtain EIS or related tax relief in respect of shares issued by the issuing company which raise money for the purposes of that activity, and One or both of conditions A and B are met. Condition A is that, as a (direct or indirect) result of the money raised by the issue of the relevant shares being employed as required for the purpose of the qualifying business activity, an amount representing the whole or the majority of the amount raised is, in the course of the arrangements, paid to or for the benefit of a party to the arrangements or a person connected with such a party. Condition B is that, in the absence of the arrangements, it would have been reasonable to expect that the whole or the greater part of the component activities of the relevant qualifying business activity would have been carried on as part of another business by a person who is a party to the arrangements or a person connected with such a party. Thus the No disqualifying arrangements requirement is wide-reaching in its effect and great care is needed in seeking advance assurance for companies as described in Section 8 above, to ensure sufficient information is given to HMRC to enable them to determine if this requirement is met. Updated to Finance Act 2013 PwC 19
11. Conclusion The EIS offers individuals very significant income and capital gains tax incentives to invest in certain unquoted trading companies, and CGT deferral opportunities to certain trustees. Prior to receiving monies from EIS investors, such companies may in their set up phase have received funding from individuals who claimed reliefs under the provisions of the Seed Enterprise Investment Scheme. Given the similarity of the qualifying conditions, the company might receive funding from a Venture Capital Trust as well as from an individual. It might also issue options to employees under the Enterprise Management Incentive Scheme. Overall there is now an interesting and varied range of tax relief opportunities available to investors in small and growing companies. We are pleased to advise about any of these tax efficient opportunities. It should be noted that the legislation is extremely complex and great care is needed by both the investor and the company if the tax reliefs are to be obtained and retained. Furthermore, investment in unquoted companies is generally considered to carry a high risk. Accordingly, professional advice should always be taken to determine whether or not a particular tax planning strategy is appropriate. Updated to Finance Act 2013 PwC 20
12. Further information Telephone E-mail address Philip Hare 020 7213 2639 philip.s.hare@uk.pwc.com or your local PwC contact. PwC Winners of the EIS Association Best EIS Tax Adviser Award 2006 to 2012 Updated to Finance Act 2013 PwC 21
This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. 130606-080924-CF-OS