Tax Relief
There are two key, and very generous, tax breaks to look for when it comes to investing in unlisted private companies, both of which can be ‘carried back’ to the previous tax year.
The objective of this article is to provide a user friendly guide to the benefits on investing in a company via EIS/SEIS.
1) Enterprise Investment Scheme (EIS) Overview
The Enterprise Investment Scheme (EIS) is designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.
This guide provides an overview for companies and potential investors who have heard of the Scheme and want to know more about it and how it works..
What makes it even more attractive is the ‘carry back’ facility where investments can be applied to the preceding tax year.
What tax reliefs are available
Income Tax Relief
There is no minimum investment through EIS in any one company in any one tax year. Tax relief of 30% can be claimed on investments (up to £1,000,000 in one tax year) giving a maximum tax reduction in any one year of £300,000, provided you have sufficient Income Tax liability to cover it.
EIS allowances are allocated individually; therefore a married couple could invest up to £2 million each tax year and be eligible for Income tax relief. The shares must be held for at least three years from the date of issue or the tax relief will be withdrawn.
People connected with the company are not eligible for Income Tax Relief on their shares.
Capital Gains Tax exemption (CGT)
Any gain is CGT free if the shares are held for at least three years and the income tax relief was claimed on them. Shares can be held for much longer and therefore potentially enable the investor to be accrue their CGT exemption over a long period of time which can be a great attraction.
Loss relief
If shares are disposed of at a loss, the investor can elect that the amount of the loss, less Income Tax relief given, can be set against income of the year in which they were disposed or, on income of the previous year instead of being set of against any capital gains.
Capital Gains Tax deferral relief
Payment of CGT can be deferred when the gain is invested in shares of an EIS qualifying company. The gain can be made from the disposal of any kind of asset but the Investment must be made one year before or three years after the gain arose – connection to company does not matter. Unconnected investors are eligible for relief from both Income tax and CGT referral relief.
Carry Back
There is a ‘carry back’ facility which allows the all or part of the cost of shares acquired in one tax year, to be treated as though those shares had been acquired in the preceding tax year. Relief is then given against the Income Tax liability of that preceding year rather than against the tax year in which those shares were acquired. This is subject to the overriding limit for relief for each year.
Restrictions
Connection to the Company
Should the investor be connected to the company, they are not eligible for Income Tax Relief. Connections are defined through financial interest or employment.
Connection by financial interest
An individual is connected with the company if they control the company or hold more than 30% of the share capital or voting rights. These conditions apply for up to 2 years before and 3 years after the share issue. If during this time, the individual becomes connected, then the relief will be withdrawn. All relatives except brothers and sisters are included within these restrictions.
Connection by employment
Partners, directors and employees of the company are all connected with it and therefore not eligible, as are associates. Associates are business partners, trustees and relatives. Again, these conditions apply for up to 2 years before and 3 years after the share issue.
The only exceptions are Business Angels – where the connection is as a director who receives no remuneration from the company.
Claiming your tax relief
The investor can only claim relief once the company sends through an EIS3 form. Claims are made through the Self-Assessment tax return for the tax year in which the shares were issued.
Claims can be made up to five years after the investment after the first 31 January following tax year in which investment was made.
Tax relief that is reduced or withdrawn
Tax relief will be withdrawn if you become connected to the company or if the company loses its qualifying status.
The relief will be either reduced or withdrawn if the Shares are disposed of or if the investor receives “value” from the company such as a loan or an asset below market value.
Examples
Here’s a few examples of how EIS tax relief works. To make the math’s easy, let’s assume you invest £20,000 in each case and you’re in the 45% tax bracket.
Case 1: The Company does well and doubles its value and you hold the shares for three years
Investment = £20,000
Income Tax relief = £6,000 (as a reduction in your income tax bill)
Capital Gains Tax = £Zero
Your gain = £26,000 (£20,000 profit from the sale plus £6,000 income tax relief)
Case 2: The company value stays the same
Investment = £20,000
Income Tax relief = £6,000 (as a reduction in your income tax bill)
Share sales = £20,000
Your gain = £6,000 (from the income tax relief)
Case 3: The Company closes and your shares are worth nothing
Investment = £20,000
Income Tax relief = £6,000 (as a reduction in your income tax bill)
At risk capital = £14,000
Loss relief on at risk capital @ 45% = £6,300
Your actual loss = £7,700 (£20,000 – [£6,000 + £6,300])
The Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) is designed to help small, early-stage companies raise equity finance by offering tax reliefs to individual investors who purchase new shares in those companies. It complements the existing Enterprise Investment Scheme (EIS) which offers tax reliefs to investors in higher-risk small companies. SEIS is intended to recognize the particular difficulties which very early stage companies face in attracting investment, by offering tax relief at a higher rate.
SEIS applies for shares issued on or after 6 April 2012. The rules have been designed to mirror those of EIS as it is anticipated that companies will go on to use EIS after an initial investment under SEIS.
What are the benefits of SEIS for investors?
Investors can receive initial income tax relief of 50% on investments up to £100,000 per tax year in qualifying shares issued on or after 6 April 2012
A CGT exemption will offered in respect of gains realised on the disposal of assets, that are reinvested through SEIS in the same year
The individual investor can be a director of the company, but not an employee
An individual’s stake in the company can be no more than 30%
SEIS tax relief applies only to recently incorporated companies
The company must have 25 or less employees and gross assets of up to £200,000
Examples
As with our EIS tax relief examples, we’re going to keep the numbers straightforward and assume you invest £10,000, pay income tax at 45%
Case 1: The Company does well and doubles in value
Investment = £10,000
Income Tax Relief = £5,000 (you get 50% of your investment back as a tax bill reduction)
Profit from sale = £10,000
Capital Gains Tax = £Zero (if you have held the shares for three years)
Tax free return = £15,000
Case 2: After three years the company’s value is the same
Investment = £10,000
Profit from sale = £Zero
Your gain = £5,000 reduction in your income tax bill
Case 3: The company folds and the shares hold no value
Investment = £10,000
Income Tax Relief = £5,000 (you get 50% of your investment back as a tax bill reduction)
At risk capital = £5,000
Loss relief = £2,250 (45% of at risk capital)
Your actual loss = £2,750 (£10,000 – [£5,000 + £2,250])
Things to remember
First of all, check that the pitch you’re interested in has got SEIS ‘advanced assurance’ – this is a certificate emailed to the investor by HMRC confirming that investors will benefit from SEIS.
Secondly, you can claim your money back once the business has been trading for a minimum of four months or has spent 70% of the investment they received.
Finally, and this is a big one, SEIS relief can be claimed up to five years after the 31st January in the year you made the investment.
How to claim
When the company you’ve invested in has been trading for four months or spent 70% of the total investment, the company must submit form SEIS1 to HMRC (or, more specifically, the Small Companies Enterprise Centre otherwise known as the SCEC).
Once SEIS1 has been reviewed and the requirements met, the SCEC will issue a copy of form SEIS3 for every investor. These are sent to the company of they can be passed on to each investor for them to complete and submit as part of their tax return.