For many small, start-up businesses, the last few years have proven to be very testing times where achieving external investment has been concerned.
This is due in part, to the fact that the small business financing route of simply taking a loan from a high street bank (or other freely available lender), has become much more difficult to rely upon due to the banks strengthening their own balance sheets through 'less risky' lending.
New businesses have therefore had to consider other options available to them in order to manage and grow a successful start-up business.
With the backdrop of this generally difficult business landscape to contend with, the Government has attempted to assist small businesses in obtaining much needed investment, by widening the scope of the venture capital tax reliefs available.
Their aim? To incentivise 'business angels' and other investors to invest in higher risk start-ups.
Over the last number of years, the government have increased the investment limits for the Enterprise Investment Scheme ('EIS') whilst also introducing a new sister relief, SEED EIS, which was set up to provide greater levels of tax relief for very small start-ups.
These venture capital reliefs are considered to be 'state aid' for EU purposes, and therefore EU approval is necessary. Further changes are proposed from 2015 for which state aid approval is pending.
Whilst the reliefs provide a good framework to encourage growth in smaller companies, it is important to be aware that such investments are likely to be higher risk. Furthermore there are a number of detailed conditions for both the company and the investor, which need to be complied with over a period to ensure that the expected relief is available.
For the purposes of this article, we have concentrated mainly on EIS relief.
The Enterprise Investment scheme (''EIS'')
EIS investors are able to benefit from tax reliefs in the following three ways:
Income tax relief
Subscribing for shares in an EIS qualifying company will provide income tax relief at 30% of the invested amount (provided the investor has sufficient income to benefit from the relief) up to a limit of £1million each year, resulting in a possible annual income tax reduction of £300,000. (This annual limit has increased significantly over recent years to attract greater levels of business investment).
In addition to this relief being available for income taxes due in the tax year of investment, there is also flexibility as to when an investor would like for the relief to be used. This is due to a carry back claim being available for the prior year (in certain circumstances) which could result in a repayment of taxes already paid.
Capital gains tax relief (“CGT”)
In addition to the income tax relief detailed above, the investments will also potentially benefit from CGT relief. This relief essentially exempts any gain made on the disposal of the EIS shares, provided they have been held for at least three years at the date of sale, and the qualifying conditions have been met throughout that three year period.
CGT deferral relief
Finally, it is possible to defer CGT on the disposal of any asset, provided an investment is made in EIS qualifying shares within three years from selling the original asset (or one year before the disposal).
Once the investment is made, the CGT that would have been payable on the disposal of the original asset is deferred, until such time as the EIS shares are disposed of (or the qualifying conditions fail to be met). It should be noted that the amount available for deferral is the amount reinvested.
In addition to the above benefits, business property relief (“BPR”) is generally available against the EIS shares after two years of ownership (subject to all BPR conditions being met). BPR is an inheritance tax (“IHT”) relief which essentially removes the value of the shares held from an individual’s estate for IHT purpose, resulting in a potential IHT saving of 40%.
As mentioned above the qualifying criteria for EIS approval is very tightly drawn, and in practice, it can be a real minefield to ensure that all of the requisite conditions are met for the necessary period and professional advice on qualification should be sought. In particular, for income tax and CGT relief, an investor must not be connected with the Company; broadly this includes holding paid employment, being a paid director (with some exceptions) or holding, with associates, more than 30% of the Company.
HM Revenue & Customs (“HMRC”) do offer a clearance facility to assist companies in ensuring that they do not fail any of the qualifying requirements and advice should be sought on making such an application.
SEED EIS (“SEIS”)
SEIS works in much the same way as EIS, though the income tax reducer stands at 50% of the amount invested (up to a £100,000 limit).
CGT exemption also applies on the disposal of SEIS shares, provided they have been held for three years or more. In addition, re-investment relief is also available for SEIS shares where a disposal of any asset is reinvested in SEIS shares (same time limits as EIS) but with SEIS, the relief exempts 50% of the amount reinvested from CGT altogether, rather than providing a deferral.
EIS benefits example
Let’s consider Mr Y, an individual with high levels of income, who has recently sold one of his rental properties and made a £500,000 capital gain.
Typically this gain would be chargeable to CGT at up to 28%, resulting in a potential tax charge of £140,000.
If, in the next three years, Mr Y were to invest the £500,000 (made on the property sale) in shares in a new EIS qualifying company, then the original gain made would be deferred until such time as the shares were disposed of.
In addition to this CGT deferral benefit, there would also be an income tax reducer available to Mr Y of £150,000 (i.e. the £500,000 investment x 30%).
Finally, if after three years the EIS company had thrived, and the shares had tripled in value say, then Mr Y’s investment would be standing at a £1.15million profit (£1.5million less the net cost (after tax relief) of £350,000).
Under normal circumstances this gain would be subject to CGT at up to 28%. However, as the investment qualified for EIS, there would be no CGT charge as the gain would be completely exempt.
As such, the only tax payable on both disposals (including the original property sale) would be £140,000 i.e. the amount deferred, and it is possible to defer tax this again with a further EIS investment.
The overall tax relief achieved would therefore stand at £430,000 (made up of £150,000 income tax reducer and £280,000 of CGT relief).
Clearly, this example is an ideal scenario for any would be investor and it should not be forgotten that the relief is only available as a means of incentivising investment in smaller, higher risk businesses and therefore in many cases losses rather than profits may arise. The net loss made would be eligible for relief against income or capital gains. Investors should always seek professional investment advice before making any such investment.
In addition to 'business angel' investors benefitting from the EIS reliefs highlighted above, it could also be relevant for other small businesses. For example, it is possible for a business owned by four individuals, to each benefit from EIS relief on the shares they have acquired in the business, provided they are not 'connected' for EIS purposes (see above). It is therefore important to note that EIS is not only a relief to encourage investment by external investors, but it is possible for tax relief to be available on investments made in your business, by you.
If you have a business or are thinking of setting one up and would like to understand more about EIS, you should contact a member of our specialist team at Deloitte.
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Any investment mentioned in this article is for illustrative purposes only and is not intended as investment advice. Any tax advantages mentioned are based on current legislation accurate at the date of print which is subject to change. The opinions expressed in this document are not the views held throughout Brewin Dolphin. No Director, representative or employee of Brewin Dolphin accepts liability for any direct or consequential loss arising from the use of this document or its contents
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