Jacqui Gudgion, tax director of Mercer & Hole explains why the Enterprise Investment Scheme (EIS) creates high expectations for company and investors, which need to be carefully managed.
The expectation is that EIS tax relief is great for investors, which it is indeed. The small and medium-sized companies which use EIS see it as a tool to help bring on board new investors into the business, and that there should be with no problem of obtaining HMRC approval of the company being qualified to use the scheme. However, that is not as easy as it once was.
The body of EIS legislation has changed over the last few years leaving tax advisers on the receiving end of a process of endless complexity and, where not carefully managed, an expectation gap between their clients and what can be achieved. Some of the key challenges that the average company looking to raise capital is often unaware of from the headlines are set out below.
Company age requirement
There is a requirement that the EIS investment is received no more than seven years (ten years for a knowledge-intensive business) of the company’s first commercial trade. There is an exception to this if the funds are required to raise money for a new activity (new product or new geographic market) but this age condition is a surprise to many.
When applying for advance assurance for the EIS company, HMRC requires a lot of detail if the new product or new geographical market exception is to be relied upon. HMRC have been known to raise challenges where the distinction between new and old activities is not crystal clear. When the EIS scheme is used to raise money to breathe new life into an existing enterprise the age requirement needs to be carefully considered.
Risk to capital
The relatively new risk to capital requirement can be a tricky concept for the enthusiastic entrepreneur who is trying to ‘sell’ their business idea as a shrewd investment. The condition that the company must use the money for growth and development is relatively straight forward. However, the requirement that the investor is risking the loss of more capital than they are likely to gain as a net return, is something that can be difficult to articulate when you are sure the business will make you a millionaire!
A rather nasty bear trap is the requirement that all of an existing investment held by a shareholder in a company must have attracted relief under EIS, SEIS (Seed Enterprise Investment Relief) or Social Investment Tax Relief (SITR).
This tripped up one of our clients. A pioneering company had the support of our client as an investing benefactor for many years. One year (prior to the EIS requirement for existing shareholders) there was a need for our client to raise a little bit extra to invest. This tipped him over the annual amount of investment which would qualify for income tax relief, but as he was firm in his belief of the success of the business and was not investing purely for the tax relief, he found the additional funds.
Roll forward a few years and he was stunned to find that his next investment in the same business would not qualify for tax relief. This was because that small extra investment had not been made under EIS. This made no sense to our client. He had been so loyal and committed to this business, but now he was blocked from investing further under the EIS scheme in that business. As a result of this perverse rule, he was only able to invest a lower sum, as the tax relief for him as an investor affected the amount of net funds he was able to release.
These are some of the little surprises which can trip up clients who only look at the headlines of EIS relief. No-one can doubt that EIS is indeed an excellent tax break for both the investor and the small and medium-sized company market. For many straight forward cases, EIS is the essence of opportunity for success.
EIS eligibility flowchart
Building on years of experience of working with new and growing businesses, Mercer & Hole’s Corporate and Business Tax team have developed a simple EIS eligibility flowchart to help businesses looking to raise funds with EIS to undertake an initial check of eligibility for the scheme.
About Jacqui Gudgion
Jacqui Gudgion is a chartered tax advisor with over 25 years’ experience in practice. A member of the Corporate and Business Tax team at top 40 firm, Mercer & Hole, Jacqui has spent a majority of her career working with business and individual entrepreneurial clients. She is an expert on EIS matters and has recently been awarded the EISA Diploma by the EIS Association (EISA), of which she is also a member.