What are the latest changes to the EIS?
Recap
The enterprise investment scheme (EIS) is a collection of generous tax incentives that rewards the subscription of shares in qualifying trading companies - colloquially referred to as “EIS companies”. Perhaps the most well-known relief is the income tax reduction, which is calculated as 30% of the amount invested. Your clients are subject to a cap on the maximum investment they can claim relief on in each tax year - this is currently £1 million for 2017/18, although they can utilise a carry-back facility.
Abusive arrangements
One of the requirements to secure this income tax relief is that the shares are held for a minimum period. This will be at least three years but could be up to five years if the EIS company hasn’t commenced trading at the time the investment is made. EIS investments tend to be high risk because the company will be small, relatively new, and there may be no clear route to sell shares once purchased.
Over the years, a number of schemes have been marketed which have sought to offer investors a capital preservation investment under EIS. This will typically involve a company that meets the EIS legislation, but in reality is mainly set up to secure the 30% relief for investors after the (assumed) three-year holding period is over, whilst returning as much of the original capital as possible.
Pro advice. This is especially powerful when combined with IHT planning, as EIS company shares will typically qualify for 100% business property relief after two years.
In response, the legislation has been repeatedly tightened, and in keeping with this, the Autumn 2017 Budget and subsequent Finance Bill 2017-19 (see Follow up ) contained a new measure that will narrow the scope of the relief even further.
New condition
The new condition, which will constitute s.157A Income Tax Act 2007 , is intended to ensure that there is a genuine risk to the investing client’s capital. This is in keeping with the overarching objectives of the EIS scheme in general, that is to say encouraging outside private investment for new entrepreneurial companies as an alternative to traditional finance options (like bank loans).
The new condition will apply from the date that the new Finance Bill 2017-19 receives Royal Assent, and will require that it is “reasonable” to conclude that both:
- the issuing company has objectives to grow and develop its trade in the long term; and
- there is a significant risk that there will be a loss of capital of an amount greater than the net investment return (including the value of any EIS relief).
Pro advice. The obvious problem here is the subjective term “reasonable”. It’s increasingly used in modern anti-avoidance terminology, and seems to tilt things in favour of HMRC - but at the end of the day it is open to interpretation. Be prepared to argue a robust defence on behalf of your client, where necessary, but also remember that the new rules are mainly there to attack artificial arrangements.
Proving that there is a “significant risk” in defence of a genuine investment might be problematic. The term is not defined in the draft legislation, and so will apply on a case-by-case basis.
Post-investment checks
HMRC has updated its guidance at VCM8550 (see Follow up ), and this indicates that post-investment checks to ensure that the risk to capital was genuine will take place. If it determines that information supplied at the time of the investment was incomplete or misleading, relief originally given could be withdrawn. These checks will also look at whether the money has been used for the purposes stated at the time.
Pro advice 1. Note that the new condition will also need to be met for seed EIS (SEIS) investments.
Pro advice 2. Because the new condition will only apply to investments made after the date that Finance Bill 2017-19 receives Royal Assent, advise any clients contemplating making an investment where the condition might not be met to ensure they do so before that date.
Advance assurance changes
During 2017 there was a consultation on how best to streamline the advance assurance process, as there was concern that it takes too long. The government published its response to the input in December 2017 (see Follow up ). It makes clear that HMRC will no longer provide an opinion in respect of speculative applications. These are applications where there is no indication that an investment is imminent. HMRC says that almost a third of assurance applications are not followed by an investment.
To tackle this, since 2 January 2018, HMRC will not issue an opinion unless you provide the names of the potential investors - whether they be individuals, fund managers or other promoters.
In addition, since 4 December 2017, it will not issue an opinion if it appears that the risk to capital condition will not be met - even though the condition does not yet apply!
Pro advice. This gives rise to a tricky issue, as many companies have pointed to an advance assurance opinion as a way of making an investment attractive to potential investors. Make clear to your clients that an advance assurance is non-statutory, and is non-binding in any case, and that they can still assure potential investors that an opinion will be sought before any investment is made.
Note that this applies to all the venture capital schemes, so includes the EIS, SEIS, venture capital trusts, and social investment tax relief.
It is also worth noting that the response document commits to digitising the process, so it may soon be possible to make an online application.
Max investment to increase
It wasn’t all doom and gloom though - the Budget also announced that the annual amount that an investor can claim EIS relief for will double from £1 million to £2 million for investments made on or after 6 April 2018. However, this will only apply to investments made into knowledge-intensive companies (KICs).
To be considered a KIC, the company must either have spent at least:
- 15% of its operating costs on research and development or innovation in one of the three years preceding the investment date; or
- 10% of the costs in each of those three years.
In addition, it must also either be able to demonstrate innovation to create intellectual property that will be exploited, or have a workforce that consists of at least 20% skilled employees.
Pro advice. Detailed guidance on whether a company is a KIC is available at VCM8161 (see Follow up ).
Example. Sarah makes a £1 million investment into a trading company in May 2018. This is the maximum amount she can claim EIS relief on for a non-KIC. If she wanted to, she could make further investments into KIC companies of up to £1 million and claim relief in 2018/19.
Annual company limit
A further boost announced was that a company which qualifies as a KIC will also enjoy a doubling of the limit on the amount of finance it can raise in a twelve month period. Currently, this stands at £5 million, but from 6 April 2018 this will increase to £10 million for KICs. Both of these limit increases are subject to approval from the EU Commission on State Aid.
Finance Bill 2017-19
VCM8550
Response to consultation
VCM8161
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