Fledgling businesses may be crushed by inability to correct SEIS errors

Tue 17 Oct 2017

X-Wind is an ill-wind that still blows no good for SEIS and EIS companies.

Another company has fallen victim to the inflexibility of the rules on applying for SEIS approval and HMRC’s refusal to allow a company to substitute an SEIS1 for an EIS1 that was submitted in error. In the First-tier Tribunal (FTT) Innovate Commissioning Services argued that its situation was different from past cases, including what is currently the leading Upper Tribunal decision in X-Wind Power Ltd. v HMRC (Let’s Talk Tax 2 October 2017).

Like X-Wind, Innovate had submitted the wrong form, EIS1, when it should have used form SEIS1, showing investments of precisely £150,000; the maximum amount it could raise under a first round of SEIS funding. SEIS is only available to a company that has not previously raised any funds under EIS:

• therefore it is essential that any SEIS funding be completed correctly before the company issues shares under EIS;
• X-Wind established that there is no legal provision for rectification where EIS is applied for by mistake in relation to the first round of funding; and
• HMRC are not prepared to allow companies that applied for EIS in error to withdraw their EIS applications and instead replace them with SEIS.

Innovate claimed that its case was different from X-Wind in that HMRC were aware of a potential flaw in the EIS application and so should not have given EIS approval, meaning that HMRC’s EIS approval was invalid, Innovate had not made any share issued under EIS, and an SEIS application could still be made.

Innovate’s second argument was that HMRC were also aware that Innovate was considering SEIS because Innovate had obtained advance SEIS clearance from HMRC.

Innovate’s case was not helped by the fact that HMRC had twice written to it with queries before granting EIS approval. The reason why HMRC’s queries went unanswered was that Innovate had changed address without informing HMRC and so did not receive the queries.

The FTT rejected Innovate’s arguments and upheld HMRC’s decision.
Innovate and X-Wind are just two cases involving SEIS/EIS procedural errors that have been litigated but there have been many others. There seems to be a flaw in a system that allows innocent procedural errors to frustrate legislation intended to promote risk investment in new business.

Fatal errors

Consider the scale of the potential damage that EIS and SEIS failures can cause in terms of the tax losses likely to be suffered by investors. Those investors may seek recompense from the investee company for lost:

•  income tax relief (30% of investment under EIS, 50% under SEIS);
• CGT hold-over into the shares, providing deferment in EIS and the possibility of 50% of the gain rolled over under SEIS becoming effectively completely exempt; and
• CGT exemption on the gains on the EIS/SEIS shares themselves.

The loss of CGT exemption is potentially the largest claim and is unlimited. The amount claimable would often be unquantifiable when a claim was made and so an estimate would have to be placed on the value of the lost opportunity, so the investor’s litigation against the company itself would be expensive.

Remember that SEIS is a scheme designed to support fledgling companies that depend on every penny of investment they can attract. Losing SEIS may well be fatal to many a small business.