Back in 2015, the Government announced changes to the availability of EIS relief to investors who already hold shares in the capital of the investee company. These rules still catch out investors with the result that they are unable to claim EIS on investments they make.
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.
Where do investors come unstuck?
Section 164A of the Income Tax Act 2007 imposes 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.
Investors get caught by this provision because they have been issued with shares for services by the company. Often this relates to remuneration for any advisory or board role that they agree to carry out.
If the investor makes an investment in circumstances where he already holds shares (including those 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 investment meeting all the other requirements of the EIS rules including:
(i) that the investor is not (and does not become) an employee; and
(ii) that there are no related transactions associated with the investment made by the investor under EIS. In other words, the EIS investment should not be conditional on the investor being granted options or other benefits.
Investors should remember that income tax will be payable by them at their marginal rate on the market value of any shares acquired by them on the exercise of the option. Market value is now directly linked to the last investment round price for loss-making companies (or where there is a sale, the sale price).