8.3 Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) was introduced in 1994 to encourage equity investment in small unlisted enterprises carrying on a qualifying trade in the UK. For detailed guidance see HMRC Venture Capital Schemes Manual VCM10000 and HMRC Helpsheet HS431.
Eligible enterprises can use the Scheme to attract up to £5m of equity investment in any twelve-month period. It provides tax relief for individuals (not corporate bodies) and is worth 30% of the cost of the shares, to be set against the individual’s income tax liability for the tax year in which the investment is made. The shares must be new and additional capital and must be held by the individual for at least three years after they were issued or the enterprise started trading, whichever is longer.
The capital raised must be used to finance the qualifying business activity. Early withdrawal of share capital by a member will result in a loss of tax relief for that member, but it would not jeopardise the tax relief of other members, especially if the amount withdrawn was not substantial, taken to mean less than £1,000. However, if the society was routinely allowing members to withdraw share capital within three years, including members who did not receive EIS, this could jeopardise the eligibility for tax relief of all members. The maximum amount of individual tax relief that can be claimed in any one tax year is currently £300,000.
Although EIS is primarily targeted at private companies limited by shares, societies are also eligible, subject to the same restrictions that are imposed on companies, requiring share capital to be fully at risk, without any guaranteed or pre-arranged exits for the investor. This means that a society must have the powers to suspend or refuse applications to withdraw share capital. HMRC recognises that withdrawable shares are not the same as redeemable shares, and does not treat them as such, as long as the society has these powers.
The Finance Act 2015 introduced a number of reforms to EIS, including new qualifying criteria to limit relief to investment in “knowledge intensive” enterprises within ten years of their first commercial sale, with all other qualifying enterprises required to be within seven years of their first commercial sale. This will not apply to enterprises where the investment represents more than 50% of turnover averaged over the preceding five years. It also introduced a new restriction preventing the investment funds from being used to acquire existing businesses or business assets. Taken together, these new criteria mean that many community led buy-outs of existing enterprises such as shops, pubs and football clubs will no longer be eligible for EIS.
Enterprises engaged in non-trading activities, such as investment deals or property rental, are not eligible for EIS. This means that societies that acquire assets, such as pubs, which are leased to a tenant, do not quality for tax relief. Similarly affected are societies that raise capital to invest in managed workspaces, or community buildings that are rented or leased to user groups. To qualify for EIS, the non-trading income of a society must not exceed 20% of its total income.
Most trades qualify, but some do not and these are referred to as “excluded activities”. Among the excluded activities are some which are very popular with community businesses, such as electricity and energy generation, farming, market gardening, woodland management, and property development. Also excluded are any activities that count as investment, not trade, such as property rental. Some activities such as room hire are more difficult to determine, especially where it is packaged with trading activities such as conference facilities or wedding receptions. In these cases, the VAT treatment of the activity may be helpful in determining whether it is a trading activity.
In March 2018 HMRC introduced an additional “risk-to-capital” condition in an effort to stamp out “capital preservation” schemes. HMRC will apply a principles-based test to ensure that the capital raised is genuinely being put at risk within the enterprise and not being preserved, for instance through the acquisition of property, or the retention of cash balances. Enterprises are now required to submit a full business plan as evidence of the risks to which the capital raised will be exposed. Advance assurance applications should emphasise the risks to capital highlighted in the risk register of the business plan.
There are also rules about the maximum size of the enterprise. It must employ fewer than 250 full-time equivalent employees and gross assets must not exceed £15m. The enterprise must be an independent entity and not controlled by another person or entity; it may have subsidiaries as long as they are all majority owned, or at least 90% owned if the EIS capital is to be invested in the subsidiary.
EIS is administered by the Small Company Enterprise Centre (SCEC) at HMRC. The SCEC is responsible for deciding whether an enterprise and its share issue qualify for the Scheme. It does this by checking that the enterprise’s accounts, governing document, business plan and other documentation relating to the share issue, comply with the requirements of the Scheme. The SCEC operates an advance assurance scheme, whereby an enterprise can submit their plans and documents in advance, using the form EIS(AA), and the SCEC will advise on whether or not the proposed share offer is likely to qualify. Advance assurance applications can be made for any of the venture capital schemes, including Seed Enterprise Investment Scheme (SEIS) and Social Investment Tax Relief (SITR).
In 2018 HMRC introduced measures to reduce the number of “speculative” advance assurance applications it deals with, by requiring enterprises to provide evidence that they have identified potential investors in their scheme. It is not clear what evidence will satisfy HMRC that a scheme has community support, which could range from a list of pledged investors to less specific evidence of community engagement and support derived from community meetings, surveys and the like. The Office of Civil Society has obtained reassurances from HMRC that enterprises applying for SITR will be exempt from these requirements for the time being.
Advance assurance is not mandatory; an enterprise and its investors can still qualify for the scheme after the shares have been issued, but potential investors are likely to take comfort from advance assurance when deciding whether to invest.
Connected persons are not eligible for EIS tax relief. This includes anyone who is an employee, paid management committee member, or large shareholder (defined as holding more than 30% of the share capital) of the enterprise, or anyone who is an associate of such a person. An associate is defined as a spouse or civil partner, lineal ancestor or descendant, a business partner, or certain persons with whom the individual has connections through a trust. Joint shareholders (see Section 3.2.4) are treated as though they invested an equal amount for tax relief purposes, even if they have not contributed equally to the joint purchase. If shares have been bought as a gift, it is the recipient, not the purchaser, who receives the tax relief (see Section 5.9). Offer documents should make it clear that applicants should check they are eligible for tax relief before relying on it. HMRC provide guidance on this matter through its helpsheet HS431.
Regardless of whether advance assurance was obtained or not, the enterprise must submit a compliance statement (form EIS1) to the SCEC after the shares have been issued and the enterprise has been trading for a minimum of four months. If the SCEC accepts that the enterprise, its trade, and the shares all meet the requirements of the scheme, it will issue form EIS2 to that effect, and supply sufficient forms EIS3 for the enterprise to send to the investors so they can claim tax relief.
In order to claim EIS tax relief investors must first obtain a form EIS3 from the enterprise they have invested in. The investor should use this form to claim the tax relief for the year in which the shares were issued, or it can be carried back to the previous tax year. If the investor normally pays income tax by PAYE and the total tax relief is less than £5,000 then the tax relief can be claimed in one of two forms: either as an adjustment to the PAYE code if the tax relief is being claimed in the current financial year, or as a carried back claim against income tax on the previous year, in which case the investor will receive the tax relief as a lump sum repayment. If the investor is claiming more than £5,000 in tax relief and currently pays income tax through PAYE, they will be asked to complete a Self Assessment tax form. If the investor already completes an annual Self Assessment form then they should claim the tax relief the next time they submit this form.
Investors can also benefit from capital gains tax deferral relief if they are reinvesting capital gains made elsewhere into an EIS eligible enterprise.