Investors receive a number of significant tax benefits if they qualify for EIS relief. Companies looking for investment from UK domiciled angel investors should be aware of this and ensure that their investment will allow the investor to claim EIS relief.
Eligible individuals (eg business angels who satisfy relevant conditions) investing in new shares issued by a qualifying company can secure the following tax benefits:
- capital gains tax (CGT) deferral relief – tax realised on the disposal of another asset can be deferred by reinvesting the gain realised on that disposal in EIS eligible shares;
- income tax relief – 20 per cent income tax relief can be secured in respect of the amount invested in EIS eligible shares, subject to an annual limit on the amount invested of £500,000;
- CGT exemption – an exemption from CGT in respect of any capital gain realised on the disposal of the EIS eligible shares.
Here is further information on the above reliefs, and a summary of the main conditions to be satisfied in order to secure the reliefs:
CGT Deferral Relief
Deferral of tax arising on the disposal of any other asset is available if the EIS investment is made in the period beginning one year before and ending three years after the date the gain arose.
There is no limit on the amount of the gain to be reinvested in the EIS shares which can attract the deferral relief.
The conditions to be satisfied (relating to the company in which the reinvestment is made, the shares acquired and the application of the money reinvested) are set out in the appendix to this briefing. In addition, the investor must be UK tax resident.
The tax deferred by making the reinvestment becomes payable in prescribed circumstances, which include the following:
- the investor disposes of the EIS shares (the subject of the reinvestment);
- the investor becomes non-UK resident within three years of the investment; and
- the EIS shares cease to be eligible shares (see the Appendix) during the period of three years after their issue.
Deferment is not always advantageous. There can be circumstances in which the tax payable following the period of deferment will be greater than that which would have been payable on the original disposal, if no deferment had been sought.
Income Tax Relief
Twenty per cent income tax relief is available on amounts invested in EIS eligible shares, subject to a minimum annual amount invested of £500 and a maximum amount of £500,000.
An election can be made to treat the shares as having been issued in the previous tax year, so that income tax relief can be claimed in that previous year (eg where the £500,000 limitation was not utilised in the previous year).
It is necessary to obtain an EIS certificate from the investee company and HMRC must authorise the company to issue this.
The conditions to be satisfied (relating to the company in which the investment is made, the shares acquired and the application of the money reinvested) are set out in the Appendix to this Briefing. It is possible to obtain a provisional clearance from HMRC, in advance of an investment being made, that the relevant conditions will be satisfied.
In addition the individual making the investment must not be “connected” with the company for a period from two years before the issue of the shares (or the date of incorporation, if later) and ending three years after the issue of the shares, or after the trade commences, if later. The individual will be treated as connected with the company, and so not eligible for income tax relief, if he/she:
- has, or is entitled to acquire, more than 30% of the issued ordinary share capital and loan capital or of the voting power of the EIS company or any of its subsidiaries; or
- is employed by, or is a director of, the company or any of its subsidiaries (or a partner of the company or any of its subsidiaries); or
- is a partner of the company of a subsidiary.
The individual can qualify for relief, even though he/she is “connected” with the company solely by reason of being a director, if, when the shares are issued, he has never before been connected with the company or involved in carrying on its trade. In such circumstances it is also possible for the director to receive reasonable remuneration for his duties as a director and the individual will not be disqualified if he also becomes an employee. This relaxation of the connected persons rule is aimed at business angels who are to make their expertise available to the company.
Relief will be withdrawn if the shares are disposed of within the period ending three years after the issue of the shares, or after the trade commences, if later. Relief will also be withdrawn to the extent that the investor receives value from the company in the period starting twelve months before the date of acquisition and ending three years after that date, or after the trade commences, if later).
An exemption from CGT on a disposal of the EIS shares made more than three years after their acquisition, or after the trade commences, if later.
This exemption is only available for shares which have qualified for income tax relief.
If income tax relief is not given on the full amount invested (eg because the amount exceeds the permitted maximum) the CGT exemption will be restricted to a proportion of the gain.
This Briefing summarises some of the main features of EIS rules, based on the law in force on February 26, 2011 and including references to changes announced in the June 2010 Budget. The relevant legislation is lengthy and detailed, and includes specific anti-avoidance rules not touched on in this Briefing. Specific advice should be sought in relation to the facts of any particular case. These materials are provided only for general information.
Keystone Law’s Tom Daltry has more than 26 years of experience as a tax lawyer and was head of tax at Eversheds before becoming a consultant lawyer. He has acted for a broad range of clients, ranging from entrepreneurs and management teams to private equity houses, large plcs/multi-nationals and financial institutions. You can reach him via email here.