This article was first published in the May 2005 UK edition of Accounting and Business magazine.
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The chancellor has challenged business. He has challenged it to invest, to export and to build the economy. In return, he has set out the further actions the government will take in order to help to build the appropriate environment. This includes reforms to support growth.
The Finance (No 4) Bill includes three enterprise initiatives to encourage growth by investment in business. The first, the Seed Enterprise Investment Scheme, is aimed at small business startups and is, on the face of it, the most generous, as it is aimed at the riskiest investments. Changes have been made to the Enterprise Investment Scheme (EIS) and the Venture Capital Scheme to increase some limits, simplify the scheme rules and give further incentive to invest.
Seed Enterprise Investment Schemes
Schedule 6 of the Finance (No 4) Bill 2012 introduces Seed Enterprise Investment Schemes (SEIS) into UK tax provisions from 6 April 2012. These provisions are there to run alongside the EIS and the Venture Capital Trust (VCT) regimes and are presented as amendments to the Income Tax Act 2007. Unless otherwise specified, references are to the proposed legislation as amended.
The scheme relates to shares issued from 6 April 2012 until 5 April 2017, but this term may be extended. It is available to individual investors in small companies, but not to investors in partnerships or LLPs (section 257AA).
The investment limit for a qualifying individual in a fiscal year is £100,000 (section 257AB). However, the investor cannot claim tax relief until the company has spent at least 70% of the money invested (section 257CC). The individual must not be an employee of the company from the date of its incorporation until at least three years following the issue of the shares. A director is not an employee for this purpose (section 257BA).
The investor must not have a ‘substantial interest’ (more than 30% of the ordinary share capital or votes (section 257BF and 257BB), and anti-avoidance provisions counter prearranged exits or loan arrangements (section 257BC, 257BE and 257CD).
Investment must be in cash and must be invested in shares which are fully paid when issued (section 257CA). The shares cannot carry a preferential right to dividends, assets on a winding up, or redemption (section 257BB). They must be held by the investor for three years after the issue. There will be a clawback of relief if the shares are not held for the requisite period or if the company ceases to meet the trading requirement (section 257DB).
The relief is income tax relief of 50% (section 257AB) and any gain will be exempt (sections 257AE and 150E TCGA 1992), provided the investor (or spouse or civil partner) held the shares for the three years following the issue (section 257AC). Where a spouse or civil partner receives the shares from the original investor, it is the recipient who will be charged to tax on any clawback on a disposal (section 257H).
Relief under Schedule 5BB of TCGA is available for reinvesting the proceeds of assets that would otherwise give rise to a chargeable gain (section 257AE).
To obtain the relief:
- The company must be new, incorporated within the two years prior to the issue of the shares.
- The shares must be issued to raise money for a new trade and the cash raised must be spent within the two years following issue (section 257HF).
- The total of SEIS investments must not exceed £150,000.
- The company must exist for the purpose of carrying on one or two new qualifying trades (section 257DC).
- It must have a permanent establishment in the UK and its shares must be unquoted (section 257DD and 257DF).
- The total value of the company’s gross assets must not exceed £200,000 at the time of issue. The relevant proportion of the assets of a related company must be included in this total (section 257DI).
- The total full-time equivalent employees must not exceed 25 at the time of issue; employees include directors for this purpose (section 257DJ).
- There must be no EIS or VCT investment in the company before the SEIS shares are issued (section 257DK).
The relief must be claimed and the individual must receive a compliance certificate from the issuing company (section 257ED). The company cannot issue the certificate until it has spent at least 70% of the cash for the purposes of the qualifying activity (section 257CC). Insignificant amounts unspent are ignored.
The company also needs authority from HMRC before it can issue the certificate. To do this it must give a compliance certificate under threat of penalties for fraudulent certificates or claims (section 257EC, 257ED and 257EF).
The claim must be made within five years of the normal self-assessment filing date (section 257EA).
Enterprise Investment Scheme and Venture Capital Trust
In the Budget the chancellor announced amendments to the EIS and VCT rules to help companies which face barriers in raising external equity finance to compete for finance, making it easier for these companies to grow. Schedule 7 of the Finance (No 4) Bill 2012 contains the changes to the Enterprise Investment Scheme, and Schedule 8 the amendments to Venture Capital Trusts.
When subscribing to shares in a qualifying EIS company, an individual will receive tax relief in their income tax computation.
From 6 April 2012 income tax relief is given as a tax reducer at a flat rate of 30% (20% prior 6 April 2012) on the lower of the amount subscribed or £1,000,000 (previously £500,000).
The tax liability can be reduced to nil by EIS relief, but cannot create a negative figure for the tax liability.
Significant changes to EIS surround the criteria for a qualifying company.
The scheme provides tax relief where an individual subscribes for new shares in a qualifying company. The relevant shares must be issued for genuine commercial reasons, and not as part of a scheme or arrangement the main purpose of which is the avoidance of tax. The company must not guarantee the investor any sort of return on their investment. There must not be any prearranged exits.
A qualifying EIS company is an unquoted trading company carrying on its activities mainly in the UK.
There are certain prohibited or excluded trades for EIS purposes. Some of these activities are banking, insurance and other financial activities, legal and accountancy services, farming and market gardening, managing hotels, managing nursing or residential care homes and property development. The comprehensive list can be found in sections 192–200, Income Tax Act 2007.
The EIS rules place a limit on the value of the assets of the company. From 6 April 2012 the gross assets of the company must not exceed £15m (section 11a), previously £7m, before the share issue and must not exceed £16m (section 11b), previously, £8m, after the share issue.
The full-time employee limits qualifying condition for companies and groups have been increased from 50 to 250 from 6 April 2012.
The maximum amount raised through EIS has increased by £3m and from 6 April must not exceed £5m per annum.
The company must use 90% of the cash raised from the issue of EIS eligible shares within 12 months and the remainder within 24 months, for trading purposes.
To obtain income tax relief, the investor must not be connected with the issuing company. An investor is connected to the company if they are an employee or a partner of the company. An investor can be a director of the company as long as they receive only reasonable remuneration for their services.
An investor is also connected to the issuing company if they directly or indirectly possess or are entitled to acquire more than 30% of the ordinary share capital or they can exercise more than 30% of the voting rights. In considering whether the 30% limit has been breached, the shareholdings of spouse, parents, siblings and children must also be considered.
There will be a clawback of the income tax relief originally given if an investor disposes of their shares within three years of issue.
If the shares are sold within three years, to an unconnected third party, the income tax relief to be withdrawn is the sale proceeds multiplied by the rate at which tax relief was originally given.
The clawback cannot exceed the original tax reducer. So if the shares are sold at a profit, the investor tax liability is increased by an amount equal to the original tax reducer. The increase is in the year in which the shares are disposed of.
Venture Capital Trust
If an individual subscribes for shares in a VCT, a 30% tax reducer is given on the lower of the amount subscribed or £200,000. As with EIS investments, the tax reducer is limited to the individual’s tax liability.
A VCT is actually a company whose shares are quoted on a stock exchange. The company must ensure that at least 70% of its investments are in shares in qualifying companies. A qualifying company meets similar criteria to EIS qualifying companies.
As with EIS there are restrictions with regard to trade, number of employees, company assets limit before and after the investment, as well as a maximum amount raised in a year through the issue of shares qualifying for VCT.
The bill includes increases for employee numbers (section 9), company asset limits (section 8) and amounts raised in the year (section 2) that apply from 6 April 2012 and mirror the EIS limits.
A VCT cannot invest more than 15% of its funds in any one company. So from an investor point of view, an investment in VCT is less risky than an investment in an EIS. As a VCT invests its funds in a number of different companies, the investor is spreading the risk over a number of companies.
An important difference from EIS is that dividends on the first £200,000 invested in VCTs in the tax year are tax free. Also a VCT company must distribute at least 85% of the income which it derives from its investments.
There is a withdrawal of income tax relief if an investor disposes of their shares in the VCT within five years.
Income tax relief will also be withdrawn if the VCT loses its HMRC-approved status within five years.
If VCT shares are sold at a profit, the gain is exempt from tax, regardless of the length of ownership. Any losses on a sale of VCT shares will never be allowable. However, the above exemption only applies to the first £200,000 of shares acquired in the year.
If a VCT loses HMRC approval, the investor is treated as disposing their shares at the market value on the day approval is withdrawn.
Mirela Dewshi, technical adviser and Mary Fraser, technical consultant, ACCA