Set out below is my guide to the new SEIS, followed by some brief comments on the new regime.
The Enterprise Investment Scheme (“EIS”) has been around for many years, as an incentive for investment in higher risk unquoted companies, with the rate of income tax relief on investment currently 30%, and various capital gains tax advantages such as deferral of gains into EIS investments and tax exemption for disposals of certain qualifying EIS shares.
In the 2011 pre-Budget Report, the Chancellor announced the introduction of the SEIS with effect from 6 April 2012, designed to stimulate investment in very small start-up companies with an income tax relief rate of 50% on qualifying sums invested. This guide explains how the SEIS works, what tax reliefs are available, and which individuals and companies are eligible for the scheme.
Income Tax relief
Income tax relief is available to individuals who subscribe for qualifying shares in a company meeting the SEIS requirements, and who have a UK tax liability against which to set the relief (note that investors do not have to be UK resident). The investment must be held for a minimum period of 3 years, otherwise relief will be withdrawn.
Tax relief is available at 50% on the cost of the shares, to an annual maximum investment of £100,000 (i.e. the maximum tax relief is £50,000). The relief is given by way of a reduction in tax liability, assuming there is sufficient tax liability to absorb the relief.
It will be possible for tax years from 2013-14 onwards to carry back relief to the previous tax year, but this is not possible for 2012-13 as there was no SEIS in 2011-12.
Capital gains tax reliefs
For 2012-13 only, if a capital gain is realised and the gain is wholly or partly reinvested in SEIS shares eligible for income tax relief, the amount re-invested will be exempt from capital gains tax. There will be a carry back facility for 2013-14 investments against 2012-13 gains in this respect.
Where SEIS shares have been held for at least 3 years, their disposal will be free from capital gains tax.
Requirements re: SEIS shares
The shares must be paid up in full in cash when issued, and must be ordinary shares, carrying no preferential rights in a winding-up of the company. If the shares have preferential dividend rights, the amount of that dividend must not be variable, and the right to dividends must not be cumulative (i.e. there is no requirement for the company to pay the dividend at a later date if it cannot do so at the correct time).
There must be no arrangements to protect the investor from normal investment risks, and no arrangements for the shares to be sold at the end of the 3-year period. The shares may not be paid for using a loan on beneficial terms from the investee company, and business owners may not make reciprocal arrangements to obtain tax relief on investment in each other’s businesses.
The investor must not have an interest greater than 30% in the company in the 3-year qualifying period from the date of issue of the shares. This applies to issued share capital, voting rights or rights to assets in a winding up. Shareholdings of associates are taken into account, including business partners, trustees of settlements created by the investor or of which he is a beneficiary and relatives (excluding brothers and sisters).
The investor must not be employed by the company in the 3 years from the issue of the shares, but he may be a director of the company.
Tax relief can be withdrawn during the 3-year period if any of the above conditions cease to be met, or if the shares are disposed of (other than to a spouse or civil partner).
At the time of issue of the shares
The company must be unquoted (includes companies quoted on the AIM or PLUS markets).
It must have fewer than 25 employees.
It must have no more than £200,000 in gross assets.
It must not have had any investment from a Venture Capital Trust or investment under the EIS.
It may not raise more than £150,000 under the scheme (any excess will not be eligible for relief).
Any trade being carried on at the date of the share issue must be less than 2 years old, and the company must not have carried on any other trade prior to the existing trade.
Continuously from incorporation date
It must not be controlled by another company.
It must not be a member of a partnership (including an LLP)
Any subsidiaries must be more than 50% owned and not controlled (using the assets in winding-up & voting control tests) by any other company.
Continuously from date of share issue
The company must be UK resident or have a permanent UK establishment.
It must exist wholly for the purpose of carrying on a qualifying trade.
There is no requirement to begin a qualifying trade within a specified period, but the intended trade must be clearly identified and identifiable, and the use of the SEIS monies should clearly reflect that intention.
Use of SEIS monies raised
All the monies raised must be used within 3 years for the purposes of a ‘qualifying business activity’ (NB this excludes payment of dividends). A qualifying business activity is carrying on a new qualifying trade, preparing to carry on a new qualifying trade which the company intends to, and subsequently does, carry on, or engaging in research and development which will lead to or benefit a new qualifying trade.
The trade must be carried on a commercial basis with a view to profit. There is a list of excluded activities that do not qualify; this is as follows:
Dealing in land, commodities or financial futures;
Dealing in goods other than by retail or wholesale distribution;
Banking, money lending, insurance, debt factoring, H P financing and other financial activities;
Leasing or letting assets on hire;
Receiving royalties or licence fees (unless from an intangible asset created by the company itself);
Providing legal or accountancy services;
Farming or market gardening;
Woodland and timber production activities;
Coal or steel production;
Nursing homes or residential care homes;
Generation or exporting of electricity attracting a Feed-In Tariff, unless generated by hydro electric power or anaerobic digestion, or unless carried on by a community interest company, a co-operative society or a community benefit society.
There will be an HMRC advance assurance procedure, to allow companies to submit details of their plans and obtain a ruling as to whether the SEIS is likely to apply.
Formal application for SEIS approval can only take place once a company has been trading for 4 months or, if earlier. It has spent 70% of the money raised under the SEIS.
A claim for relief will be made on the self-assessment tax return.
This is an extremely generous relief, which is appropriate, in that it applies to extremely risky investments. Having said that, the availability of the CGT exemption for 2012-13 or 2013-14 gains rolled into a 2012-13 SEIS investment offers a higher rate taxpayer a rather staggering potential 78% rate of tax relief (50% income tax relief plus 28% capital gains tax exemption), and we can therefore expect the new scheme to attract a considerable amount of attention.
What it seeks to achieve is completely consistent with the government’s long-term strategy for the UK economy, which is that we are fast becoming a high-tech economy, with expertise in research and development and high-end manufacturing, and that a significant part of future economic growth will stem from agile small businesses exploiting technological advances and bright new ideas. As such, I am an unreserved supporter of this regime, and hope to see it enjoy resounding success in the years to come.
One interesting feature is the exclusion of siblings from the definition of associates, which means that we may see some family companies being able to take advantage of this regime, despite the 30% substantial interest test. And very much like the EIS, groups of 4 or more unrelated equal shareholders starting a business may well all be eligible for relief under the SEIS. Thus there are significant tax planning opportunities here for those prepared to undertake significant amounts of risk.