Looking to raise funding under the Enterprise Investment Scheme (EIS)? You must meet these conditions…

In the second of a series of blogs, Roger Phillips, director in PM+M’s tax team, further explores the Enterprise Investment Scheme (EIS).

In the first article, Roger looked at the income tax and capital gains tax reliefs which are available to individuals who make qualifying investments under the EIS. Click here to read more.

In this article, Roger focusses on the company in which the investment is being made, including conditions which must be met to successfully qualify for the scheme.

EIS conditions

There are a whole host of conditions that need to be met by a company which is looking to raise EIS funding. As a starting point, the company needs to be ‘trading’ in nature and have a UK presence.

We highlight some of the well-known conditions in this article, however there are many others, along with some traps for the unwary, and it is very easy to fall foul of the rules, either before the investment, at the time it is made, or in the period after investment.

This can be expensive, as a failure to satisfy the rules at the outset, or a slip up in the three years following the issue of shares, can cause problems for your investors – potentially meaning a loss or claw back of their valuable tax reliefs.

We look at some (but not all) of the conditions below.

‘Risk to Capital’

The first condition that needs to be met before you even consider the others, is the ‘Risk to Capital’ condition – this is the ‘gateway’ to EIS.

If the ‘Risk to Capital’ condition is not met, an investment will not qualify, full stop. If it is met, then there may then be the potential to secure EIS relief for your investors.

The ‘Risk to Capital’ condition looks to determine if, at the point an investment is made, a company is one with genuine entrepreneurial aspirations – with intentions to develop and grow.  HMRC also need to be satisfied that the investor’s capital is genuine ‘risk’ money – i.e., there needs to be a significant risk of the loss of the investment if things go wrong.

Once the ‘Risk to Capital’ condition can be shown to be satisfied, there are a whole host of other conditions that need to be met by the company, including, but not limited to:

Further conditions

The ‘gross assets’ test:

    • the company must have gross assets of no more than £15m before the investment, and £16m after.

The ‘employees’ test:

    • The company (or group if it has subsidiaries) can’t have more than 250 employees at the time of the investment.

The ‘maximum age limit’ test:

    • The shares need to be issued no later than 7 years after the company’s first commercial sale. If the company is ‘knowledge intensive’ these rules are relaxed slightly.
    • In certain circumstances, the 7 year period can be extended, for instance, if the money being raised from the investment is being used for the purposes of the entering of a new product or geographical market.

The ‘unquoted’ requirement:

    • The company must not be quoted and there can’t be any arrangements for it to become quoted.

The ‘share’ requirement:

    • The shares that are being issued to the investors need to be ‘ordinary shares’ which can’t be redeemed.
    • The shares can’t carry any preference to dividends or capital in the event of a winding up.
    • Care also needs to be taken to ensure that the shares aren’t seen to have any favourable conditions in terms of them being protected in the event of a sale (the so called ‘pre-arranged exits’ test).
    • Careful drafting of the articles is therefore paramount here.
    • In addition, amendments to a company’s articles at a later date can cause problems for EIS shareholders. For instance, if a new share class is created that ranks behind the EIS shares, this could cause a loss of EIS relief. This is often seen if a company creates a ‘growth’ or ‘flowering’ share class for example.
    • If growth shares are already in issue, you also need to tread carefully.

The ‘purpose’ test:

    • The shares must be issued in order to raise money for the purpose of a ‘qualifying business activity’ and the issue must be for the ‘growth and development’ of the company or one of its ‘qualifying subsidiaries’ (see below).

The ‘use of funds’:

    • The money invested needs to be spent within 2 years of the investment and it needs to be used for the purposes of the trade.
    • The money can’t be used to acquire another business, another company, or goodwill.
    • The company needs to demonstrate to HMRC how the money will be spent, and how spending it will assist the company to grow and develop.
    • The money has to be spent by the company or a ‘qualifying subsidiary’ – broadly one where the company holds 90% or more of the shares.

The ‘trading’ requirement:

    • The business of the company or group must substantially be ‘trading’ in nature. Investment activities can therefore present difficulties, as can the undertaking of certain other activities, such as receiving royalties and license fees.

Certain kinds of activity are excluded from qualifying for EIS. These include companies or groups which undertake, either wholly or in part, the following:

  • Dealing in land, shares or commodities.
  • Property development.
  • Farming.
  • The operation or management of hotels or nursing homes.
  • Financial activities.
  • Legal or accounting services.
  • Leasing.
  • Shipbuilding and coal and steel trades.
  • Receiving royalties and licence fees[1]
  • Energy generation activities

There are a whole host of other conditions that need to be met by the company which we do not cover in this article. Get in touch if you would like to find out more.

‘Advance Assurance’ Procedure

We would always recommend that before seeking to raise finance under EIS, the company seeks an ‘Advance Assurance’ from HMRC that it will indeed qualify for EIS relief.

Having an ‘Advance Assurance’ in hand can put the company in a stronger position when looking to raise funds from external investors.

This will provide comfort to those prospective investors that they will be able to benefit from the tax reliefs that EIS offers (click here to read more).

Get in touch

We have a multitude of experience in dealing with EIS fundraising, including advising companies, investors and dealing with HMRC’s Small Companies Enterprise Centre in terms of obtaining Advance Assurance for clients. If you would like to discuss your situation in more detail, please get in touch with Roger by clicking the button below.

 

[1] unless those royalties/license fees relate to intellectual property where more than 50% of its value was created by the company

 

This document is for general information purposes only and in no way constitutes advice. By their nature, EIS investments are inherently risky, and you should always seek independent financial advice before investing. You should also seek tax advice prior to investing.

 

For more information about anything in the above article, please get in touch using the button below.
Roger Phillips
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