The EIS Guide

What is EIS and how can you benefit from it?

The Enterprise Investment Scheme – or EIS – is a special tax incentive scheme designed to help a lot of growth businesses attract investment. Most individual investors will expect to get the valuable tax reliefs that come from investing in an EIS qualifying business.

This guide will help you answer the following questions:

• Can my company qualify for EIS?
• If it does, what’s the benefit to my investors?
• What kind of investors can qualify?
• Does the investment need to be structured in any particular way?
• How does it work in practice?
• Do I need to do anything after issuing EIS certificates?

Businesses which are very early-stages should consider whether they qualify for the Seed Enterprise Investment Scheme (SEIS) before they consider EIS, because the tax reliefs for investors are more generous, even if the amounts you can raise are much more limited. We have a Cube guide on that scheme available here. There is also a scheme which incentivises investment from Venture Capital Trusts (the VCT scheme).

This guide gives a summary of some of the key conditions which must be met to obtain the various EIS tax reliefs. The full conditions are very wide-ranging and have evolved to counter various tax avoidance schemes and perceived abuses of the generous tax reliefs available. The gov.uk website contains a good description of all of the conditions and is an excellent source for those looking to investigate further.

https://www.gov.uk/guidance/venture-capital-schemes-apply-for-the-enterprise-investment-scheme

The EIS rules include a special category of ‘knowledge intensive company’ or KIC – the rules are generally more generous for KICs than for non-KICs. KICs are companies which have a strong focus on innovation / R&D, but the detailed conditions to qualify as a KIC are described in this HMRC guide.

Can my company qualify for EIS?

First of all your company must exist wholly for the purposes of one or more “qualifying” trades for three years following the later of:

• the relevant issue of EIS-qualifying shares; and
• the date on which the company starts to carry on the trade;

Not only are investment companies excluded, but the company must also not be carrying on certain kinds of excluded trading activities e.g. trading in land or securities, various financial and professional services, leasing businesses, hotel and nursing home businesses – a full list of excluded activities is available by following this link. If your company has subsidiaries then this test – and all the qualifying criteria - must generally be met by looking at the group as a whole.

Companies must raise their first EIS investment within 7 years of making their first commercial sale (or within 10 years if it’s a KIC). There are some limited exceptions to this “age” requirement. Periods in which the business was carried on by a previous owner count for these purposes (so you cannot, for example, transfer an old business into a new company and qualify for EIS).

The company issuing the shares must have a “permanent establishment” in the UK (broadly, a business presence here) but that does not prevent it having business establishments overseas, or overseas subsidiaries.

There are size limits for companies which can qualify for EIS, although these are much less strict than for SEIS. The company must have gross assets of less than £15m before the investment, and less than £16m after the investment. It must also have fewer than 250 full-time equivalent employees (or fewer than 500 such employees if the business is a KIC). The “gross assets” test measures a company’s assets ignoring any liabilities or debts.  So a company with assets of £20m and debts of £20m will have gross assets of £20m, and will not be able to attract investments under the EIS regime.

The company cannot be listed on a stock exchange and it must be independent (for example, not under the control of any other company, although it’s acceptable for it to be majority owned by an individual).

The company must also be able to demonstrate that there is a real “risk-to-capital” for all investors rather than merely aiming to preserve capital asset values. This condition was introduced to ensure that heavily asset-backed trades could not secure tax-favoured investment. EIS is designed to encourage investment in entrepreneurial businesses that carry real risk, which is where the Government feels that the tax reliefs can do most good. In addition, there is an express requirement that the purpose of the fund-raise is to raise money for a qualifying business activity “so as to promote business growth and development”. In other words, EIS money needs to be raised to promote the organic growth of the business (such as increasing revenues, customer base, product range). It cannot be used to acquire an existing business or prop up a business that is simply struggling for lack of working capital.

The company must also spend the money on the intended qualifying trade within two years of the investment (or, if later, within two years of starting to trade).

If it does, what’s the benefit to my investors?

EIS investors can get income tax relief equal to up to 30% of their EIS investments (up to £1m annually, or £2m if they invest in KICs). For example, if an investor invests the maximum £1m they will get £300k of tax relief. So, if they have other income that gives rise to an income tax bill of £450k in that year, this bill will be reduced to £150k by income tax relief. If the whole relief cannot be used in the tax year of investment, there is scope to carry it back to the previous tax year.

There are also two capital gains tax (CGT) reliefs – a deferral relief, and potential exemption from CGT for the shares themselves. 

The way the deferral relief works is that if someone makes a capital gain (for example, on real estate) in one year and reinvests it entirely in EIS shares the next year, they can defer paying tax on that original gain until such time as they dispose of the EIS shares. There is a complete exemption from CGT on the sale of the EIS shares themselves, if they have been held for at least three years from the date the shares were acquired (or the date the trade started, if later) and if they qualified for income tax relief.

Finally, loss relief is also available. If an investor acquires EIS shares and they ultimately make a loss, then that investor can claim that loss (net of income tax reliefs given up-front) against both capital gains and income to further reduce their tax bill.

Reliefs are generally only retained if the investor holds on to the shares for three years or more (starting on the later of the date of the EIS share issue and the date on which the company started trading). In this way the scheme is trying to incentivise sustained investment rather than short-term speculation.

What kind of investors can qualify?

EIS reliefs are only available to individual investors (not companies or partnerships looking to invest). Because the reliefs are available against UK tax it will mostly be UK tax-resident individuals who are interested in investing for EIS. You may also come across SEIS and / or EIS ‘funds’ – these are different to many fund investors because they use a nominee structure, so that the ‘fund’ investment is in effect lots of investments from the individuals participating in the structure.

A qualifying investor must not have a substantial interest in the company (being a 30%+ holding), either on his own or together with any associates of his (for example, business partners, spouses, children). Employees and directors cannot generally qualify, although there are limited exceptions to this rule for unpaid directors and paid ‘angel investor’ directors who have had no previous connection with the business. They should only be appointed as directors after they have invested.

Does the investment need to be structured in any particular way?

The investment itself should be for fully paid-up ordinary shares, and the maximum amount which one company can receive in a year under EIS is £5m, or £10m if it is a KIC (note that these limits include any other SEIS and VCT funding). It’s important to take care with the investment process. For example, individuals won’t be able to benefit from EIS if they lend money to the company, with a plan to convert it into shares in due course. The EIS shares must be issued immediately in exchange for a fresh injection of cash.

In addition to the annual cap for qualifying investments, there are overall / lifetime caps on EIS/VCT investment for any one company of £12m (or £20m for KICs).

The annual allowance is reduced by certain kinds of state aid received from other sources, so be careful if you are benefiting from any other state aid scheme.

There is also an overriding requirement that the shares be subscribed for genuine commercial reasons and not as part of a tax avoidance scheme.

How does it work in practice?

Companies looking to accept EIS investment can seek advance assurance from HMRC that the proposed investment will qualify by writing to them with full details. This is not compulsory, but some investors may insist that advance assurance is obtained as a way of getting comfort that they will receive the expected tax reliefs. HMRC provide details of the process, and forms for EIS/SEIS advance assurance, on their website. However HMRC’s policy is only to accept clearance applications from companies which have already lined up (and can name) the prospective investors. Clearance cannot therefore be obtained speculatively.

Once the investment has been made, EIS investors will need a certificate from the company in order to be able to claim the tax reliefs through their self-assessment. In order for the company to have the authority to issue these certificates, it must formally request HMRC’s permission using form EIS1. In order to be able to submit a form EIS1 the company must generally have been trading for at least four months.

In these forms the directors of the company confirm that the relevant conditions have been met.  Assuming they don’t spot anything wrong, HMRC will then formally authorise the company to issue a separate certificate (EIS3) to the individual investors which they then use to claim the reliefs in their self-assessment returns.

Do I need to do anything after issuing EIS certificates?

The EIS regime requires some of the conditions to be maintained for at least three years after the share issue, or three years after commencing trading if that occurred later, in order for investors to hold on to the tax benefits of their investment. Not all of the conditions need to be met throughout that period – the company might grow in size such that it couldn’t attract new EIS investment for example, but that’s fine. Existing EIS investments won’t be disqualified. However there are many ways to lose the reliefs – for example, if the trade shifts into a non-qualifying area of business, or if the business leaves the UK altogether, or if the company comes under the control of another company, or if the company makes a prohibited return of value to some or all of its shareholders.

If you successfully receive investment under the EIS regime it is crucial that you are fully aware of what you must and must not do in order to maintain the reliefs. Not only could you come under an obligation to report breaches to HMRC, but your investors could lose all of the reliefs that they have claimed, and have to pay CGT when they sell the shares.