Enterprise Investment Scheme – Limits doubled but relief becomes more targeted

Wed 22 Nov 2017

Of interest to entrepreneurial companies and investors, was news of changes to the Enterprise Investment Scheme (EIS). The news was mixed, with a generous enhancement of available relief for those investing, was coupled with a new anti-avoidance measure which is somewhat troubling in its subjective nature.

What is EIS and what are the new enhancements?

EIS provides generous income tax and capital gains tax relief for eligible individual UK investors providing risk capital to qualifying entrepreneurial trading businesses, by way of new-issue share subscriptions.

The arrangements are popular with private, early stage, often innovative, businesses seeking business angel funding to support product and/or service development and growth to commercialise and scale business in circumstances when access to other funding capital sources may be limited (e.g. due to lack of asset security.)

This new enhancement measure forms part of the government response to the Patient Capital Review consultation on ‘Financing growth in innovative firms’, which considered the effectiveness of EIS, Venture Capital Trusts (VCTs) and the other tax-advantaged venture capital schemes.

The enhancements are intended to provide additional support to knowledge-intensive companies and comprise significant increases to the investment limits and more flexibility for receiving investments under the EIS and VCTs rules.

The annual limit for individuals investing in knowledge-intensive companies under EIS will be doubled, to £2 million, provided that the surplus over £1 million is invested in knowledge-intensive companies.

The annual EIS and VCT limit on the amount of tax-advantaged investments a knowledge-intensive company may receive will also be doubled, from £5 million to £10 million.

Greater flexibility will be provided by way of some amendments to the definition of a knowledge-intensive company for companies that have existed for less than 3 years and also via changes to the permitted maximum age rules, which will be updated to allow a knowledge-intensive company to use the date from which its annual turnover exceeded £200,000, instead of the date of its first commercial sale, when determining the date from which the end of the initial investing period is calculated.

When will the changes take effect?

For EIS the changes will apply to shares issued on or after 6 April 2018.

For VCTs the changes will apply to new qualifying investments made on or after 6 April 2018.

The legislation will be introduced in Finance Bill 2017/18 and is subject to EU state aid rules.

What about anti-avoidance measures?

The policy behind affording generous tax relief for investors is that it represents a reward for risk. This is why there are already a number of qualifying conditions that need to be met by the company and the investor. HM Treasury are concerned however that some EIS investments, that have to date successfully navigated the eligibility conditions, may still lack sufficient risk.

New anti-avoidance legislation is therefore being introduced to the EIS, Seed Enterprise Investment Scheme (SEIS) and VCT rules to exclude tax-motivated investments where the tax relief provides most of the return for an investor with limited risk to the original investment capital. The condition appears to be quite subjective and depends on taking a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors.

The new test has two parts: whether the company has objectives to grow and develop over the long-term (which broadly mirrors an existing test with the schemes); and whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return. The new ‘risk to capital’ condition requires all relevant factors about the investment to be considered in the round. The net investment return is defined by reference to the net return to investors including income or capital growth and any income tax relief. The condition will include a non-exhaustive list of the types of factors that may be taken into consideration when arriving at the conclusion.

Whilst this news on enhancements to limits is most welcome, we hope that it is also supported by a boost in HMRC manpower resources to accommodate the increased demand which will inevitably result. At present the HMRC department which handles all such applications, struggles to turn around applications in time: companies submitting EIS advance assurance applications may wait for up to 12 weeks for clearance.

For more information on the tax benefits of EIS and assurance applications to secure EIS qualifying status contact Liz Hunter, Head of Share Schemes, email: liz.hunter@mazars.co.uk