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The UK Enterprise Investment Scheme (EIS) offers generous income tax and capital gains tax reliefs to British tax payers who invest in qualifying UK companies. Relief is available to 'qualifying individuals' who subscribe for 'eligible shares' in 'qualifying companies' undertaking a ‘qualifying business activity'. The following is a summary by the directors of Shadotec plc of the rules as they would apply to Shadotec plc. However, potential investors should, if appropriate, take professional advice.
Individuals may invest any amount in EIS shares. However, only the first £200,000 invested in any one tax year will qualify for income tax relief and capital gains tax exemption. For this purpose a husband and wife are treated separately. Individuals must subscribe a minimum of £500 in any one tax year. Several subscriptions can be combined to meet these limits.
A qualifying individual is any person who has subscribed for shares wholly in cash in the company. They may not however be “connected” with that company. Connection can be by way of employment, partnership, or by being an associate (e.g. a spouse or child; but not a brother or sister) of such a person. In addition, the individual will be “connected” if he/she owns or is entitled to acquire, directly or indirectly, more than 30% of the issued ordinary share capital, loan capital, issued share capital or voting power of the company. The investor must also be a qualifying individual for the two years prior to the issue of shares and for three years after the share issue date or, if later, three years from the date trading commences. These connection conditions do not however apply to the capital gains tax (CGT) deferral mentioned below.
Eligible shares are any new ordinary shares issued in the EIS company for bona fide commercial reasons, which, throughout the period of three years beginning with the date on which they are issued, carry no preferential rights to dividends or assets on liquidation of the company. The shares must be fully paid up at the time of issue and they cannot be redeemable.
A qualifying company need not be resident in the UK for tax purposes but it must be unquoted and the money raised must be used wholly or mainly by a qualifying business activity in the UK. Companies listed on the Alternative Investment Market (AIM) are treated as unquoted for the purpose of this relief, and the directors of Shadotec plc believe that seeking a listing on the AIM may in due course be a potentially favourable course of action. The gross assets of an EIS qualifying company must not exceed £15m prior to investment nor £16m post investment.
Broadly speaking, the business activity for which the money is being raised should be conducting a qualifying trade wholly or mainly in the UK during the three years from when the shares are issued or, if later, three years from when the company commences to trade. Research and development undertaken with the intention of starting a trade is also treated as a qualifying business activity.
Qualifying trades encompass all forms of trading except for certain prohibited businesses. These include dealing in land, financial activities, legal/accountancy services and property backed activities, none of which are envisaged for Shadotec plc.
Tax relief takes the form of a credit against an individual's personal tax liability. It is given at the lower rate, currently 20%, of the sum invested subject to there being sufficient tax liability to absorb the relief. The maximum tax credit available to an individual is therefore £40,000 in each tax year.
For shares issued between 6 April and 5 October up to half of the investment, subject to an overall maximum of £25,000, can be treated as being made in the previous tax year. Other reliefs are as set out below.
If a qualifying individual holds eligible shares for more than three years from the date of issue (or from the date of commencement of trading, if later), then any capital gain on the disposal of the EIS shares after that period will be tax-free, subject to any withdrawal of the relief as mentioned below. (For inheritance tax purposes, the shares should attract 100% business property relief after two years.)
Further, if a loss arises on the disposal of EIS shares then, subject to adjusting for the income tax relief previously claimed, that loss will be available to the investor. This relief can either be claimed as a capital loss or as a loss for income tax purposes. This means that in the unhappy event of failure of the company the 80% balance of the investment not already received can be reclaimed as income tax or capital gains tax relief.
Capital Gains Tax (CGT), currently set at a maximum of 40%, on a gain from the disposal of any asset can be deferred against an EIS share subscription. The tax on any gain rolled over in this way only becomes due on disposal of the EIS shares or if the individual ceases to be UK resident within 3 years of issue of the shares. There is no requirement to obtain income tax relief to qualify for capital gains tax deferral and the amount of the gain which can be deferred is unlimited.
To qualify for deferral relief the investment must be made during the period one year before the realisation of the gain to three years after.
Furthermore, investors who defer a gain from one EIS investment to another will be able to calculate their taper relief from the earliest acquisition of EIS shares. This is an exception to the normal rule that taper relief is calculated by reference to the holding of the original asset and frozen at the point of disposal of that asset. This relief is also available to trustees of some trusts.
The directors of Shadotec plc confirm that the money raised by the issue of EIS shares will be wholly applied in qualifying business activities. The rules state that funds must be applied within 12 months of the share issue, or where it is a new trade, within 12 months of the start date, and the directors confirm that the business activities of Shadotec plc will conform to this requirement.
The EIS rules allow investors to become directors of companies into which they have invested, as long as they become directors after the issue of their shares. Such a position may be executive in nature and the individual may be remunerated accordingly.
Any disposal of EIS shares within three years of issue could have three effects:
• there may be a restriction of the EIS reliefs previously given and, if so, the relief may be clawed back;
• any capital loss arising can be set against income for the same or the preceding tax year or against capital gains in the same or subsequent tax years;
• the CGT exemption will be lost.
There are a number of conditions and time limits to be met. EIS relief may be withdrawn if the company ceases to be a qualifying company during the three year period from the date of issue of the shares (or the start of trading if later). In addition, the company could lose its EIS status if there are arrangements at the beginning of the relevant period for the company to become quoted (other than on the AIM) during the three year period.
The main conditions are:
• shares must be fully paid up when issued;
• the company must not be or become controlled by another company or companies. In the case of Shadotec plc this is not envisaged;
• if the individual investor becomes “connected” with the company during the relevant period, relief is withdrawn;
• problems may arise and cause a restriction or withdrawal of the EIS relief if companies redeem or repurchase non-EIS shares during the period commencing two years before and ending three years after an EIS issue. In the case of Shadotec plc no such non-EIS shares are in existence, and therefore no such redemption or repurchase can occur;
Investors who receive any “value” from the company within a period commencing two years prior to the issue of the EIS shares and three years after may find their relief being adjusted or withdrawn. This restriction does not apply to normal salaries for new directors, nor does it apply to interest given at a commercial rate on monies lent by any investor, dividends representing a normal return on investment or other normal commercial arrangements between the investor and the company. It is not intended that any such “value” be provided, as part of the directors' continuing intention to maintain the company's qualification sunder the EIS.
The directors of Shadotec plc have undertaken that every care will be taken to ensure that the Company remains a “qualifying company” under the terms of the EIS, and that shares will only be issued under circumstances which will ensure that they remain “qualifying shares” under the terms of the EIS.