For investors willing to take the investment risk, there are a number of schemes on the AIM Market that offer significant tax incentives. Here we discuss the intricacies of the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS), as well as the Venture Capital Trust (VCT).
What is EIS, VCT or SEIS?
The Enterprise Investment Scheme (EIS) and the Venture Capital Trust (VCT) are normally put together as they encourage investment into small-cap, unquoted trading businesses and have specific legislative characteristic in common. For the purposes previously stated, shares on the AIM market are considered unquoted. Typically, most trades qualify, however, those which are termed ‘excluded activities’ do not – an example would be dealing in commodities. Businesses can carry out some excluded activities, however they must not be substantial and by no means be more than 20% of a firm’s activities.
The EIS is formatted to assist smaller businesses raising finances by offering a variety of tax reliefs to investors who purchase new shares within AIM companies. A VCT scheme, meanwhile, spreads the risk of the investment of multiple firms since individuals invest indirectly in a variety of companies. Investors opt for shares in VCTs, which are firms listed on the LSE and are similar to those of investment trusts. Individuals may now subscribe for shares in a VCT via a nominee.
EIS income tax relief
Income tax relief is covered in Part 5 Income Tax Act (ITA) 2007.
EIS income tax relief is available for individuals who subscribe in cash for newly issued full-risk ordinary shares in a qualifying business. The investment can be straight into the firm or through an EIS fund, which will invest on behalf of the individual in multiple qualifying firms. Individuals invested in EIS funds are notably still the owner of the shares.
In order to qualify, an investor must invest a minimum of £500 worth of shares in any one business in any one tax year. The current maximum investment on which relief can be obtained is £2,000,000. For shares issued from the 6th April 2011 the relief is 30% of the cost of the share, to be set against the individuals income tax liability for the year of assessment in which the shares were issued. The maximum tax reduction in any single year is therefore £600,000, providing that an adequate income tax liability exists to cover it.
Income tax relief cannot be claimed if the investor is connected to the organisation in any of the following two ways. Firstly, by employment, a partner and/or director; and secondly, by financial interest, for example, the individual or associate holding 30% or more of the share capital. Before claiming relief, an investor must obtain at EIS3 form from the organisation which certifies that the firm has so far not breached any conditions for them being a qualifying organisation. The form can only be issued if the business has been trading for at least four months.
Typically, income tax relief is then claimed via the self-assessment tax return for the tax year which the shares were issued. If the shares were issued in a previous year, and / or if the claim is for the capital gains deferral relief, the claim part of the form must also be completed and submitted to HMRC.
EIS withdrawal or reduction of income tax relief
From the date of issue, EIS shares must be held for three years, otherwise the investor will not be eligible for income tax relief.
Relief will also be withdrawn if:
- An associate or the investor in some way become connected to the business.
- The business loses its qualifying status. Genuine commercial liquidation, however, would not end in withdrawal of relief.
Relief will be reduced or withdrawn if during that period:
- Shares are disposed of (apart from if the disposable is to a civil partner or spouse).
- The investor or an associate ‘receives value’ from the business for example, a loan.
EIS and the company
The company has to meet the qualifying rules stated in the introduction to enable investors to keep and claim tax reliefs. It is important to note that a company may be quoted and still not lose the tax relief for investors. This will only apply if no arrangements were put in place for it when the shares were issued in its initial quoting stage.
VCT tax reliefs available
In the UK, tax reliefs are only eligible for individuals over the age of 18 but not their trustees, companies, as well as those who invest in VCTs.
There are 3 types of tax reliefs for those who invest in VCTs:
- ‘Front-end’ income tax relief.
- Exemption from CGT on disposals.
- Exemption from income tax on dividends.
VCT income tax reliefs
Part 6 of ITA 2007 comprises income tax relief.
A 30% ‘Front-end’ tax relief is available form the cost of ordinary shares up to a maximum of £200,000. This is to be set against the year tax assessment of the individual in which shares are issued. The annual limit includes all VCTs and shares acquired within the taxable year and count towards the permitted maximum.
This results in individual tax liability for the year of £60,000, providing a sufficient income tax liability in place to cover it.
Shares must be held within a time frame of five years and they must not carry any preferred rights to dividends or the VTCs assets.
Claims towards a tax relief can be issued with a tax return or as a standalone claim.
It is important to note that dividends received from VCT shares are classified as “dividend relief”, exempting the holder from income tax in respect of the shares acquired within the permitted annual maximum of £200,000, and therefore these dividends do not have to be included in the tax return.
VCT refreshing income tax exemption
Measures have been put in place which prevents investors refreshing their income tax relief via investing on VCTs by placing VCT shares and then proceeding to reinvest the proceeds in new shares. The relief restricts linked shares.
A sale is deemed ‘linked’ if the investor sells shares in the VCT which has acquired shares. This also includes the successor or predecessor of the shares of the VCT and if the sale is within a 6-month time frame from each other. ‘Successor’ and ‘predecessor’ VCTs are defined in new section 264A(7) ITA 2007.
This will result in a reduction on the permitted income tax relief taking into consideration the amount sale of shares deemed as ‘linked’. This measure does not take into account the investment subscribed represented as dividends which the investor decides to reinvest.
VCT capital gains tax exemption
No charges are applied on Capital Gains Tax (CGT) when selling ordinary shares on a VCT assuming that:
- The shares were acquired within the tax year in question.
- The VCT was approved as a VCT both when the shares were acquired and when they were sold.
No minimum period is indicated for which the shares must be held. In terms of ‘dividend relief’ CGT applies for both: newly issued shares and second-hand shares.
VCT conditions for HMRC approval
To be approved as a VCT a company must comply with the following conditions:
- Income is wholly or mainly from shares or securities.
- A minimum of 70%, by value, of its investments, comprise holdings in qualifying companies.
- The holding in any company must not represent more than 15% (by value) of its investments.
- Its ordinary shares are listed on the London Stock Exchange.
- It must not retain over a 15% of the income derived from either shares or securities.
Seed investment enterprise scheme (SEIS)
SEIS scheme consists of the following:
- Companies are eligible when they consist of a maximum of 25 employees; its assets account for a maximum of £200,000, and which are carrying on or preparing to carry on a new business.
- Provides income tax relief meriting 50% of the amount given by individual investors with an investment of fewer than 30%, including directors who invest in their companies.
- Has an annual investment limit of £100,000 per investor, with unused annual amounts able to be carried back to the previous year, as under the EIS.
- Has an overall tax-preferred investment limit of £150,000 for the company. This limit is cumulative and not annually. Exempt CGT on earnings on SEIS shares.
For investors willing to take the investment risk, these schemes offer significant tax incentives. The risk is mitigated via an EIS investment as a result of the ability to receive income tax relief for capital losses.