In the Queens Speech 2015, HM Government announced changes to the availability of EIS relief to investors who already hold shares in the capital of the investee company. These changes are of relevance both to investors who have already invested in a company and to new investors.
What is EIS?
The Enterprise Investment Scheme (EIS) is a tax relief scheme for investors making equity investments in startups. It gives such investors a range of tax reliefs on their investment, the most notable of which are 30% up front income tax relief and 100% capital gains tax relief on a sale of the shares.
The rules governing the availability of EIS relief are complex. There are requirements that the investee company must meet both before the date of the investment and for three years thereafter as well as requirements that the investors must meet both before the date of the investment and for three years thereafter.
The relevance of State Aid
EIS is deemed to be State Aid by the European Union and so must comply with certain EU rules relating to how Member States may utilise State Aid for the benefit of individuals and businesses. The Finance Bill (No 2) 2015 sets out changes to the EIS Rules which reflect new EU rules on State Aid. The new EU regulations have been in force since 6 April 2015.
Although the provisions in the Finance Bill (No 2) 2015 will not be applied by HMRC until the Bill receives Royal Assent (unless the EU Commission requires HMRC to do otherwise), HMRC guidance advises investors and companies to assume that the rules are applicable from 6 April 2015.
What are the changes?
An amendment to section 164A of the Income Tax Act 2007 introduces the requirement that for an existing investor of a company to claim tax relief under EIS, all shares held by him at the date of investment must be either:
(a) a risk finance investment (i.e. shares subscribed for under the SEIS, EIS or SITR rules, for which the invested company submits a compliance statement to HMRC under section 205, 257ED or 257PB of the ITA 2007 respectively);
(b) the individual holds shares in the investee company, all of which were issued to the individual when the company was incorporated; or
(c) the investor acquired the shares at a time when the investee company had not issued any shares other than subscriber shares and had not begun to carry on or make preparations for carrying on any trade or business.
Investment before 6 April 2015
If an investor has been issued with shares in respect of an EIS investment prior to 6 April 2015, has received EIS relief on those shares and has subsequently been given shares for services to the Company (or any shares other than as part of an investment), the existing EIS relief will not be withdrawn.
Investment after 6 April 2015 but before Royal Assent
If the same investor subsequently invests again into the Company under EIS before 6 April 2015, is issued with shares after 6 April 2015 but before the Bill receives Royal Assent, a compliance statement (claim for tax relief) may still be submitted to HMRC in relation to those shares.
As the Bill has not received Royal Assent, HMRC will still apply current UK legislation when assessing a compliance statement. Therefore, provided the shares are eligible under the current UK legislation, EIS relief will be granted on those shares issued after 6 April 2015. However there is a chance that the EU commission will require HMRC to withdraw the relief. When assessing the availability of EIS relief, HMRC will only look at the date the shares were issued and not the date of the investment.
HMRC cannot guarantee the availability of EIS relief granted between 6 April and Royal Assent in relation to shares which are not compliant with the new EIS rules (as set out in the Finance Bill (no 2) 2015. After the Bill receives Royal Assent, HMRC also cannot guarantee if and when the Commission will require HMRC to retrospectively withdraw EIS relief in relation to shares issued after 6 April which are not compliant with the new EIS rules.
Investment after Royal Assent
If the investor invests under EIS after Royal Assent in circumstances where he holds shares issued for services as at the date of his investment, EIS relief will not be available on the investment.
What about a grant of options rather than an issue of shares for services?
If an investor (who meets the new EIS requirements) invests in a Company after 6 April 2015, receives EIS relief on those shares and is then subsequently granted options, HMRC will not withdraw relief because at the time of the EIS investment (assuming all other requirements are met), the investor met the new EIS requirements.
If the investor subsequently makes a further investment under EIS, so long as the option has not been exercised, HMRC have indicated that they would not take into account the grant of options when assessing the availablity of EIS relief in relation to risk investment shares.
It should be noted that all of the above is subject to the Finance Bill (No 2) 2015 being passed into law in its current format and to the application by HMRC of the legislation and its own guidance on this matter.