Introduction
The Enterprise Investment Scheme (EIS), launched by the UK government in 1994, is a powerful mechanism designed to help early-stage companies attract investment by offering significant tax reliefs to individual investors. For companies, especially those in the growth phase or looking to enter new markets, EIS can provide the vital capital needed to scale operations.
In this guide, we’ll explore how companies can benefit from EIS, the qualifying conditions, the tax reliefs available to investors, and how Laggan can assist with navigating the application process, including obtaining advance assurance and submitting a formal application.
What is the Enterprise Investment Scheme (EIS)?
The EIS encourages investment in smaller, higher-risk trading companies by offering individual investors a range of tax reliefs. For companies, securing EIS status makes them more attractive to investors seeking tax-efficient ways to support early-stage businesses.
By securing EIS eligibility, companies can significantly improve their ability to raise capital, as the tax incentives reduce the risk for potential investors. This is particularly useful for businesses that are too small to attract large institutional investors but need substantial funding to grow and scale
Benefits of EIS for Companies
Access to Growth Capital
By obtaining EIS approval, companies make themselves more attractive to a wider pool of investors, as EIS offers substantial tax reliefs. This can be the difference between securing the funding needed to scale and facing stagnation due to a lack of capital.
Improved Investor Confidence
EIS-certified companies offer investors a level of reassurance. The tax benefits mitigate risk for investors, meaning they are more likely to invest in companies that are EIS-qualified.
Flexibility in Financing
Unlike debt financing, EIS allows companies to raise funds without the burden of repayment. This gives businesses more freedom to reinvest profits in their operations rather than servicing debt.
Tax Reliefs for EIS Investors
EIS provides significant tax benefits to individual investors, making your company more appealing to potential investors. Here’s a breakdown of the reliefs available:
Income Tax Relief
Investors can claim up to 30% income tax relief on the amount they invest in EIS-qualifying companies, up to a maximum annual investment of £1 million (or £2 million if investing in knowledge-intensive companies).
This reduces the investor’s income tax liability for the tax year in which the shares are issued. Investors may also elect to carry back the relief to the previous tax year if desired.
To retain this relief, investors must hold the shares for a minimum of three years.
Capital Gains Tax (CGT) Exemption
Investors do not have to pay CGT on any gains made from the sale of EIS shares, provided the shares have been held for at least three years, and the investor claimed income tax relief on the original investment.
This exemption is particularly attractive for high-net-worth individuals seeking to minimize their tax liabilities on long-term investments.
CGT Deferral Relief
Investors can defer capital gains tax on gains made from the sale of any asset by reinvesting those gains into EIS shares.
The deferral applies to gains made up to one year before or three years after the investment in EIS shares. There is no limit on the amount of capital gains that can be deferred. The deferred gain becomes chargeable only when the EIS shares are sold or if the company loses its EIS status.
Loss Relief
If an EIS investment results in a loss, investors can claim loss relief. The loss can be set against either their income or capital gains, reducing their overall tax liability.
The relief is calculated based on the amount lost, less any income tax relief already claimed.
Inheritance Tax (IHT) Relief
EIS investments typically qualify for 100% Business Relief, meaning they can be passed on free of IHT if the shares are held for at least two years and the investor still holds them at the time of death.
This makes EIS an attractive option for estate planning and long-term wealth management.
Qualifying Criteria for Companies
To qualify for EIS and become eligible to offer these tax reliefs to investors, a company must meet several specific conditions:
Unquoted Status
The company must be unquoted at the time of the share issue. Companies listed on AIM, a sub-market of the London Stock Exchange, are considered unquoted for the purposes of EIS.
Trading Activity
The company must actively trade or be preparing to trade. It must not engage in excluded activities such as financial services, property development, energy generation, or leasing activities. At least 80% of its activities must be qualifying trades.
Size of the Company
The company must have gross assets valued at less than £15 million before the investment and £16 million immediately afterward. Additionally, the company must have fewer than 250 employees (or fewer than 500 employees for knowledge-intensive companies).
Company Age
Generally, companies must be no more than seven years old when they first raise funds under EIS. For knowledge-intensive companies, this age limit extends to ten years.
Risk to Capital Condition
Introduced in 2018, this requirement ensures that the company is genuinely entrepreneurial and taking on significant risk, with an objective to grow and develop over time. Companies must demonstrate that there is a real possibility of losing the capital invested.
Advance Assurance for EIS
Before offering shares to potential investors under EIS, companies are strongly advised to apply for advance assurance from HMRC. Advance assurance is a non-binding indication from HMRC that your company is likely to qualify for EIS.
This assurance is essential because it gives potential investors confidence that the shares they purchase will indeed qualify for the tax reliefs under EIS, making your company much more attractive to investors.
Why Advance Assurance is Important:
Investor Confidence: It confirms that your company meets EIS requirements, which is crucial for investors considering whether to take advantage of the scheme.
Streamlines the Investment Process: Having advance assurance speeds up the process once shares are issued, as both the company and investors are clear on the qualifying status from the outset.
Marketability: EIS status makes your company more marketable to sophisticated investors who seek tax-efficient investment opportunities.
Other Compliance Requirements for EIS
While obtaining advance assurance is a key first step, companies must comply with several other EIS requirements to maintain their status and ensure their investors can claim the tax reliefs. These include:
Use of Funds
The funds raised through EIS must be used for the purpose of growing and developing the business. This typically means that the money must be spent on qualifying business activities within two years of the share issue. The funds cannot be used for acquiring another business, buying shares, or any non-qualifying activities.
Holding Period
EIS shares must be held by investors for at least three years from the date of issue (or the date the company starts trading, if later). If the shares are sold before this period, investors will lose their tax reliefs, and the company must ensure investors are aware of this requirement.
No Pre-arranged Exits
The company must not have any pre-arranged agreements for the disposal, repurchase, or exchange of shares before the three-year period is completed. This includes any arrangements to reduce investment risk for the investor.
No Preferential Rights
The shares issued must be ordinary shares, without any preferential rights to dividends or assets on winding up the company. Investors must be treated equally with other shareholders.
Issuing EIS Compliance Certificates
After the company has been trading for at least four months and the investment funds have been used for the stated business activities, the company must submit a compliance statement to HMRC. Once approved, HMRC will authorize the company to issue EIS certificates to its investors, enabling them to claim their tax reliefs.
Record-Keeping and Reporting Changes
Companies must keep accurate records of how the EIS funds are used and must report any significant changes in their business structure or activities to HMRC. Failure to do so can lead to the withdrawal of EIS status and the loss of investor reliefs.
How We Can Help
We specialize in assisting companies through every step of the EIS application process. Our expertise includes:
Preparing for Advance Assurance
We guide you through the advance assurance process, ensuring all necessary documentation is in place and your application to HMRC is complete. This step requires detailed information about your business, including its structure, trading activities, financials, and future growth plans. By working with Laggan, you can ensure that your application is robust and avoids common pitfalls that might delay or risk rejection by HMRC.
EIS Compliance Review
We assess your company’s eligibility for EIS, identifying potential issues that could disqualify your business. This includes ensuring you meet the trading, size, and gross assets tests, as well as the risk to capital condition.
Submitting the Formal EIS Application
After receiving advance assurance, we assist with the formal EIS application once your company has issued shares and has begun trading for at least four months. This includes submitting a compliance statement (form EIS1) to HMRC, after which you will be authorized to issue certificates (form EIS3) to investors, enabling them to claim their tax reliefs.
Ongoing EIS Compliance
Once your company is EIS-approved, we provide ongoing support to ensure you maintain compliance with EIS rules for the required three-year holding period. We help manage any changes in your company’s activities or structure that could affect your EIS status, ensuring your investors’ reliefs remain protected.
Conclusion
Securing EIS status can be a game-changer for early-stage companies looking to raise capital and grow. The scheme’s tax reliefs make your company far more attractive to investors, giving you access to the funds you need to scale.
At Laggan, we have the expertise and experience to help your business through every stage of the EIS process, from initial advance assurance to final application and ongoing compliance. Contact us today to discuss how we can support your company’s growth through EIS.