EIS is OK: Pt 1

What is EIS?

The Enterprise Investment Scheme ("EIS") has been around since 1994. It was introduced at a time when small businesses were finding it difficult to access funding from banks. In the current economic climate it is worth looking again at EIS.

EIS is underutilised because its rules are complex. The rules were re-written in simpler language, but they still span over 100 sections of the Income Tax Act 2007.

It is almost impossible for the average businessman to read the legislation and understand exactly how EIS works. That is a great pity. There are significant tax savings that can be made by utilising EIS.

The aim of this article is to de-mystify the rules of EIS. A subsequent article will highlight how Rollits LLP can help secure the benefits of EIS.

Who might be interested in EIS?

1. Companies seeking investment.

2. Individuals looking to make investments in unquoted companies.

What are the benefits of EIS?

EIS provides significant tax breaks for the investor. EIS actually comprises three reliefs:

1. Income tax relief equal to 20% of the amount invested, so each £100 of investment only costs the individual £80;

2. Complete exemption from capital gains tax (CGT) on the sale of EIS shares; and

3. The deferral of CGT on a gain made in the period beginning one year before and ending three years after the investment in EIS shares.

An individual is entitled to EIS relief on investments up to £500,000 per year. That would give an income tax saving of £100,000. When combined with no CGT on the sale of the shares, EIS is a relief worth having!

How can you qualify for EIS?

In order to qualify for EIS income tax relief, certain conditions must be satisfied in respect of:

1. the shares;

2. the investor; and

3. the issuing company.

EIS Shares

EIS shares must be subscribed for wholly in cash and fully paid up at the time they are issued.

The purpose of the issue must be to raise money for the preparation of a trade or the carrying out of a trade by the issuing company or its subsidiaries.

The money raised must actually be used within two years after the EIS shares have been issued for the purpose of preparing to carry on a trade or actually carrying out a trade.

There can be no pre-arranged exits (like put and call options over the shares) at the time the shares are issued.

EIS Investors

The individual investor must have no "connection" with the issuing company to qualify for EIS income tax relief (this rule is relaxed for EIS CGT deferral relief). This condition must be satisfied (broadly speaking) in the period beginning two years before the issue of shares and ending three years after the issue of shares.

The investor will be treated as connected with the issuing company if:

1. she is an employee of it or any of its subsidiaries; or

2. she is a director of it or any of its subsidiaries (but see the "business angels" section below for the relaxation of this rule); or

3. she holds or is entitled to acquire more than 30% of its ordinary share capital or the loan capital and issued share capital of the company.

The investor cannot sell her shares or enter into arrangements to sell them before (broadly speaking) three years after she acquires her EIS shares. The investor can receive dividends in that period provided they are no more than a normal return on the investment. If the investor has made a loan to the issuing company then reasonable interest can be received in respect of that loan.

Business Angels

An investor can qualify for EIS even if she becomes a director after acquiring her EIS shares provided that:

1. she was not previously connected with the issuing company or involved in carrying on its trade; and

2. she only receives remuneration which is reasonable given the services rendered to the issuing company or its subsidiaries.

It might be possible for an executive who is buying into a company to obtain EIS Relief on her investment. Unfortunately, the business angels rule does not help an incumbent manager in a management buy out situation.

Issuing Company

The issuing company must be carrying on a trade or preparing to carry on a trade.

The trade cannot be any of those on a blacklist. The trades on the blacklist include: dealing in land, leasing, providing legal or accountancy services, property development, farming and market gardening, the operating or managing of hotels and the operating or managing of nursing homes or residential care homes. When the legislation was drafted the activities on the black list were thought not to be risky enough to merit EIS relief.

The issuing company cannot be quoted or have any arrangements in place to become quoted.

The company cannot be a subsidiary or under the control of another company either at the time of issue or (broadly speaking) at any point in the three years following the date of issue.

The gross assets of the company cannot exceed £7m (or that of the parent company and it subsidiaries if it is part of a group) before the EIS or £8m after it.

The company cannot have more than 50 full-time equivalent employees. This rule was introduced in 2007.

Not so complicated after all?

If you are interested in EIS relief or have any other tax issues, please contact Nasim Sharf on 01482 337336, email nasim.sharf@rollits.com.

Posted on: 11/03/2011

This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.

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