Tax efficient funding for the technology sector
The provision of business funding reliefs has been recognised by UK governments in recent years as a valuable means of incentivising investment into technology companies, writes Tim Shaw, associate partner with Ensors Chartered Accountants.
The UK provides three tax-advantaged schemes; the Enterprise Investment Scheme (EIS), the closely related Seed Enterprise Investment Scheme (SEIS) and the Venture Capital Trusts (VCT) regime.
EIS enables individual investors to invest in small and medium-sized companies (broadly with fewer than 250 employees and £15 million of assets for standard qualifying companies) in return for generous tax reliefs. By contrast, SEIS was intended to be a temporary relief but has been retained to provide relief for relatively small-scale investments – companies can raise a maximum of £150,000 under SEIS and an individual investor can claim total relief of no more than £100,000 per tax year.
EIS’s headline incentives are that an investor can subscribe for up to £1 million (per tax year) of newly issued shares in a qualifying company in return for a 30 per cent non-repayable Income Tax credit and a potential exemption from Capital Gains Tax when the shares are sold; in both cases the EIS shares must be held for at least three years.
There is a further Income Tax relief for investment losses if the investee company fails. It is also possible for investors to defer capital gains arising on the disposals of other assets by reinvestment into qualifying EIS shares.
Changes introduced from 2015 have limited the scope of EIS for many investments. For instance, investment has been limited, in general, to companies whose first commercial sale was within the last seven years.
The total permitted amount of EIS investment has been reduced to £12 million for standard qualifying companies and non-EIS shareholders have been blocked from subscribing for new EIS shares going forward, even if the company itself meets the qualification criteria.
Conversely, more recent changes have made EIS more generous for knowledge-intensive companies (the employee limit is increased to fewer than 500), both in terms of how much a qualifying company can raise (total investment limit of £20 million) and the period over which it can first raise EIS investment (up to 10 years after the first commercial sale) and how much the individual can invest (up to £2 million).
This applies to shares in companies carrying out a high level of innovation, are creating IP they intend to exploit or where at least 20 per cent of the workforce is “skilled”.
The SEIS rules give Income Tax relief equal to 50 per cent of the amount of the subscription price of the qualifying shares. Gains on the disposal of qualifying SEIS shares are exempt from UK Capital Gains Tax provided that the shares sold have been held for three years.
A capital gains’ reinvestment exemption relief also exists within the SEIS regime so that where an individual realises a capital gain, and reinvests all the gain into acquiring SEIS shares, half of the gain will not be taxable.
If the shares are sold within three years from issue, all the SEIS reliefs will be clawed back. A company cannot issue shares under the SEIS rules if it has already issued shares under the EIS rules or has received investment from a VCT.
Under both EIS and SEIS rules, in order for the favourable tax reliefs to be available it is normally necessary for both the shares to be held for at least three years from issue and for the investor and the investee company to meet the necessary conditions throughout this period – this latter point is often overlooked.
As a few words of caution, the above is just a very high-level summary of EIS and SEIS. Both reliefs are subject to a myriad of rules and complexities. For instance, in general, employees and some directors cannot benefit from these reliefs and shares cannot be issued before the cash investments are received – a common problem.
Whilst EIS and SEIS offer generous tax reliefs, HMRC often interprets the rules to the letter and many proposed investments fail to obtain relief due to unfortunate technical oversights or unintentional errors.
Professional advice both at the time of investment and going forward is essential to ensure that reliefs are obtained and are not subsequently clawed back.
A VCT is an investment company whose shares are listed on a European regulated market. It is required to invest in and maintain a portfolio of qualifying trading companies.
The investment is made by the investor into the VCT itself and this differs from EIS/SEIS in that, here, the investment is being made into an investment vehicle as opposed to the investee company. VCT is therefore a more passive investment, albeit one in which the risk of investment in specific companies is diluted.
Income Tax relief at 30 per cent can be claimed on the investment made into the VCT, limited to a maximum investment of £200,000 per tax year. This relief will be clawed back if the VCT shares are sold within five years of the date of issue.
Dividends paid by the VCT on qualifying investments are not taxable and gains made on the disposal of VCT shares are eligible for exemption from Capital Gains Tax (there is no minimum holding period).
Similar to EIS and SEIS investments, there are many rules which must be met to enable the favourable VCT tax reliefs to be available and professional advice should be taken before making any investment in a VCT.
• For more information call Tim on 01223 428314 or email: tim.shaw [at] ensors.co.uk