The enterprise investment scheme ("EIS") is a collection of parallel income tax and capital gains tax ("CGT") reliefs that can apply to investments in companies that carry on a qualifying trade. The scheme is particularly popular with start-up companies.
Two tax reliefs can apply on making an investment in EIS shares, and one on sale of EIS shares. The overall tax savings can be very large, but the EIS rules are extensive, complicated, and easy to breach inadvertently. Potential tax savings are not the only consideration for investors: companies that qualify for EIS reliefs tend to be relatively small, early-stage investments, so the investment carries considerable commercial risk.
In outline, an individual can claim a 30% income tax credit on up to £1m of investments in EIS shares each tax year. This is known as EIS investment relief. The tax credit reduces the individual's income tax liability, potentially saving £300,000 each tax year.
Further, an investor can make a claim to "hold over" taxable capital gains on disposals of other assets into an investment in EIS shares. This is known as EIS deferral relief. The deferred gain does not disappear forever: it comes back into charge when the shares are sold, or if the company ceases to qualify for EIS relief, or if the investor cease to be UK resident within 3 years.
Finally, a disposal of EIS shares after three years can be exempt from CGT. This is known as EIS disposal relief.
To qualify for the EIS tax reliefs, there are conditions that apply to the investor, the shares issued, and the investee company and its business. Most of these conditions must continue to apply for at least three years.
The investor must be a "qualifying investor", with no connection to the investee company (that is, not an employee or a paid director, and no holding or entitlement to acquire more than 30% of the shares, or assets on a distribution, or votes), no linked loans or existing shareholdings (other than EIS shares), and a main purpose of the investment cannot be tax avoidance.
The shares must be ordinary shares with no preferential rights ahead of any other shares (and in this regard, deferred shares can become an issue). They must be subscribed for wholly in cash, and must be fully paid up on issue.
The total amount raised by EIS investment in the company in the year before EIS shares are issued cannot exceed £5m, with a total amount of EIS investment in the company of £12m (but these limits are increased to £10m and £20m for knowledge-intensive companies).
The shares must be issued to raise money to promote the growth of a qualifying business activity, and all of the funds raised must be employed for the purposes of the qualifying business activity within two years. There must be no pre-arranged exits or other disqualifying arrangements, and the shares must be issued for genuine commercial reasons and not with a main purpose of tax avoidance.
The investee company and its business
There are many conditions on the nature of the investee company and its business. The company must be resident in the UK or trading in the UK through a permanent establishment. It must not be in financial difficulty when the shares are issued.
It must exist wholly for the purposes of a qualifying business activity, or as a holding company of a group of qualifying 51% subsidiaries where the group activities as whole are qualifying.
A "qualifying business activity" is in principle any trading activity (or preparations for a trade, or research and development leading to a trade), but many trading activities are explicitly excluded – so EIS relief is not available for companies that carry on activities such as property dealing or development, farming or forestry, hotels or care homes, banking or insurance, legal or accounting services, shipbuilding, coal or steel production, producing electricity, gas, fuel, heat or other forms of energy, or providing facilities to another excluded business.
The issuing company must be unquoted (not listed on a recognised stock exchange or designated exchange outside the UK – so an AIM listing is permitted) and the company must remain independent (not controlled by another company) nor have any subsidiary which is not a qualifying subsidiary (that is, each must be a 51% subsidiary, and not under the control of another company).
On issue of the shares, the company must meet the assets test – that is, at most £15m of assets immediately before the issue and at most £16m immediately afterwards – and must have less than 250 full time equivalent employees (but 500 if a knowledge intensive company).
It is often sensible for companies seeking to take advantage of the scheme to get 'Advanced Assurance' from HMRC that the shares to be issued will satisfy the requirements of the scheme. This is something many investors will expect to see.
Before issuing the shares, the company submits a compliance statement on form EIS1 to HMRC and must obtain authorisation on form EIS2 from HMRC to confirm its compliance with the EIS conditions. The company must issue compliance certificates on form EIS3 to investors who wish to claim EIS relief, and they must submit the forms to HMRC with their claim for relief.
EIS relief is withdrawn – so the income tax relief claimed on investment is clawed back, any "held-over" gain becomes chargeable, and the disposal relief will not apply – if the EIS shares are sold during the initial 3-year period, or if the conditions are not met, or if the investor receives "value" from the investee company.
After three years of compliance, the 30% income tax relief on investment cannot be withdrawn.
If and when the EIS shares are sold after 3 years to realise a gain, that gain is exempt from CGT. Any held-over gain comes into charge at that point, at the rates and rules applicable at that time, but may be held over again into another EIS investment.
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