The Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) are used by companies, typically in their infancy, to raise capital from individual investors in return for an equity stake. There are generous tax benefits for the individual, reflective of the risk that their capital might be lost if the business is unsuccessful. Details of these benefits can be found in our factsheet.
There are numerous conditions which must be met for both the company and the investor, in order for an investment to qualify for the attractive SEIS or EIS tax relief. Each condition has a specific time frame in which that condition must be met for. For some this can even begin up to two years before the investment is made and continue for three years from the share issue date. Although it is important to note this can be longer than three years for a company which has not started to trade at the point of investment.
If a condition is not met, then the consequences can lead to an investment becoming only partially qualifying or may even cease to qualify in its entirety. If so, any income tax benefit received may be clawed back in full and capital gains exemption on any increase in value on a future sale may also be lost.
Due to the various complexities, investors and investment funds often insist that a company obtains an Advance Assurance (“AA”) from HMRC, before they will make an equity investment. This will allow the company to receive confirmation that, based upon the information provided, the company is SEIS or EIS qualifying.
It is easy to see the AA as a desirable ‘golden ticket’ which helps to make the company an attractive investment opportunity for potential investors, giving them comfort they will qualify for SEIS or EIS tax benefits.
But is this always the case? Sadly not, and we explain below why investors still need to be cautious.
As suggested by the name, the AA is prepared and submitted before the investment is received, thus it provides details of the proposed investment. There are some conditions which cannot be confirmed until the actual time of the investment, such as the requirement for the shares to be fully-paid up in cash.
Whilst HMRC provide an assurance based on the information provided to them, there are situations when HMRC are not bound by the assurance they have given. These are detailed in the HMRC manuals, at VCM60140.
Included within here is if: ‘the company did not make a full disclosure of information relevant to the company’s eligibility…’.
Therefore full disclosure of the facts and highlighting any uncertainties of applying the legislation to the company’s situation is vital to get right in the application, if investors want reasonable certainty that a company will meet the conditions at the point of investment. If there is any doubt in relation to the SEIS or EIS qualifying status of the company, which is not addressed at the AA stage, investors may part with their investment on the basis of the company having an AA, whilst not realising there is a still a real risk that their investment may not qualify for tax relief.
When the investment has been made, a compliance statement (SEIS1 or EIS1) is submitted to HMRC via an online form. This is similar but very distinct from the AA application process. This time the company is notifying HMRC of the actual investment which has been made. If HMRC accept that the company qualifies, they will provide an SEIS2 or EIS2 with a scheme reference number, and a blank copy of the form that investors use to claim their income tax relief (SEIS3 or EIS3).
If a company has an AA prior to receiving the investment, is this just a formality? Not necessarily.
HMRC still review the submission made and are still within their right to ask detailed questions and request copies of documentation, including seeing copies of bank statements to evidence the shares were fully paid up at the point of share issue.
Unfortunately not, and not all investors or companies realise that the income tax relief given might be partially or fully clawed back, on various events up to three years after the share issue. For example, if a non-SEIS or non-EIS investor has their shares bought back by the company. Whilst the buy-back event does not relate to the SEIS or EIS shares, it can result in relief being clawed back for the SEIS or EIS investor and therefore the CGT exemption may also not be available.
For the investor – Does the company you are investing in fully understand the SEIS/EIS complex rules? Have they received full and complete advice from a specialist in this area? Do they have an advance assurance from HMRC? If so, how thorough was the application and did it contain all the facts? How recent is the advance assurance?
For the company – Involve a specialist tax adviser who is experienced in dealing with Venture Capital Schemes as early as possible. Obtain advice to ensure all the SEIS or EIS qualifying conditions are met at the time of the investment and for the requisite time periods after the investment has been made. Once you have received investment, ensure you seek advice before making any changes whatsoever, especially regarding any changes which will impact on the company’s share capital.
If you need assistance regarding Venture Capital Scheme matters, including SEIS or EIS work of preparing Advance Assurances, checking the eligibility of a Company, or completing the SEIS1 or EIS1 compliance statements – please contact Sonia Hands, Head of Venture Capital Tax Relief.
To find out more about what we do, please get in touch.