Improve SEIS tax efficiency
You (or one of your clients) made a successful seed enterprise investment scheme (SEIS) investment a few years ago. You now want to sell the shares to make further efficient investments, but the company can’t afford to give up that much working capital. Is there a tax-efficient alternative?
One of the conditions for SEIS relief is that the money must remain in the company as ordinary share capital for at least three years from when the business commences. If in that period you receive a return on the investment, directly or indirectly, a corresponding part of the tax break is lost. You can receive dividends and, unlike the main enterprise investment scheme (EIS), they can be a director of the company (but not an employee) during the three-year period without having to meet the critieria for the exception to being connected.
As long as the company makes profits it can pay dividends on SEIS shares in the normal way. Dividends are tax efficient, but the company can’t receive a CT deduction. But overall in most circumstances they are the best way to extract profit. The problem is that, in practice, few SEIS or EIS companies are likely to pay dividends in their early years as the aim is to grow and develop - in fact the growth aspiration is a condition for securing the SEIS status in the first place. If a company is seen to be putting shareholder returns ahead of working capital, HMRC might seek to deny or withdraw relief.
After three years you can, in theory, get your investment back without losing any of the tax breaks. But in practice this might be tricky. The company will still be relatively young and might require it to fund its operations. If it’s not able to buy you/your client out for this reason you would have to find someone to buy the shares which probably won’t be easy, as second-hand shares don’t attract the generous tax breaks. Therefore, if your capital remains locked in how can you make it work better and tax efficiently?
You could repurchase the shares, but immediately re-lend the capital to the company. The company can pay you interest on the loan. Unlike dividends, this will be deductible for CT purposes. It is also possible to pay interest where there are no accumulated profits, which could be very useful if the company was loss making in the early years.
The interest rate paid must be similar to a commerical loan. Given that the Bank of England base rate's upward trend, the loan is unsecured, and the company is likely to be viewed as a risky borrower by a third party, a return of 10% or more pa is not unreasonable. Of course, there will be other considerations for the company, e.g. the effect on other shareholding levels etc.
In summary, explore having the company convert the shareholding into an unsecured loan on which the company pays interest. This has advantages over dividends as the company can pay out even if it doesn’t have profits and it will receive a corporation tax deduction.
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