There is no more valuable tax break for individuals than EIS relief. Its great if you can qualify, but it is extremely difficult to satisfy all of the conditions and stay qualified throughout the whole qualifying period.
There are three strands to EIS:
Income tax relief on the way in
If a successful investment is made, the first £500,000 invested in each tax year can secure a 20% reduction in the individual’s income tax liability. But there is a danger, for three years after investing, that you fall foul of one of the myriad of EIS rules and your income tax relief is clawed back.
Capital gains tax exemption on disposal
If a successful investment is made and an individual continues to satisfy all of the detailed rules for, broadly, a full three years, any subsequent sale can be completely free of capital gains tax. This is the big prize.
EIS deferral relief for capital gains tax
Here the rules are less stringent. An individual, making an investment into an EIS qualifying company, can postpone the equivalent gain arising on the disposal of any chargeable asset within a specified timeframe. That original gain comes back into charge when there is a disposal of the EIS investment.
Broadly, EIS relief is available where new share capital is put into qualifying companies by outsiders and used in carrying on restricted qualifying activities. These principles frame the plethora of complex rules which often cause EIS investors not to get the tax breaks they sought at the outset.
EIS relief is available on new share capital only. Relief is denied for loans or where initial loan capital is converted into shares. Also, the investment cannot simply replace share capital taken out of the company, even by others. The shares must have no preference over any other class and no pre-arranged exits are permitted.
EIS money must be spent within two years. Clear proof is needed that the company has not used bank funding or sales revenues instead to fund the business.
The EIS company must be unlisted (although a listing on AIM is acceptable) and independent. There are narrow gross assets and employees tests so the investment must be in small, high risk enterprises. The company cannot have subsidiaries other than qualifying subsidiaries tightly defined.
The EIS company must be a trading company, or holding company of a trading group, and the trade must not include, to a substantial extent (taken as 20%), a wide range of excluded activities which the Government considers too safe. Companies receiving royalties or licence fees can get caught out here unless they are exploiting ‘home-grown’ IP.
Only outsiders, not connected with the company, qualify. This excludes any existing members of a management team or anyone (together with their associates) who can acquire more than 30% of the ordinary share capital, or the loan capital and issued share capital, or the votes. Business angels, not previously connected with the business, can become directors provided their remuneration is reasonable and they stay below the 30% threshold.
The 50 plus pages of tax legislation with 105 separate sections prove a challenge to navigate. Its hard to qualify in the first place and even harder to stay qualified for, broadly, a further three years. A cynic may conclude ‘if you think you qualify for EIS, you must have overlooked one of the rules’.