Highgate Tech Fund

EIS and the company

The following is an extract from the HMRC website www.hmrc.gov.uk/eis:

In order for its investors to be able to claim, and keep, the EIS tax reliefs relating to their shares, the company which issues the shares has to meet a number of rules regarding the kind of company it is, the amount of money it can raise, how and when that money must be employed for the purposes of the trade, and the trading activities carried on.

The company must satisfy HMRC that it meets these requirements, and is therefore a qualifying company. The process for doing this is set out at 2.5 below.

2.1 The kind of company which can use the Scheme to raise money                                                

• Must be an unquoted company at the time the shares are issued. That means it cannot be listed on the London Stock Exchange or any other recognised stock exchange. It can subsequently become a quoted company without the investors losing relief, but only if there were no arrangements for it to become quoted in existence when the shares were issued. For the EIS rules the Alternative Investment Market (AIM) and the PLUS Quoted and PLUS Traded Markets are not considered to be recognised exchanges, so a company listed on those markets can raise money under the EIS if it satisfies all the other conditions.

• Must not be controlled by another company (or another company and any person connected with that company). Nor must there be any arrangements in existence for it to be controlled by another company at the time the shares are issued. However, where a company needs, for commercial reasons, to put a new holding company above itself and:

- all the shares in the old company are exchanged for shares of the same kind in the new holding company

- various other conditions, set out at VCM15200, are met

the tax relief applicable to the old shares is effectively transferred to the new shares.

• May have subsidiaries, but if it does they must all be qualifying subsidiaries – i.e., the company has more than 50 per cent of the ordinary share capital of the subsidiary, and it is not controlled (by other means) by another company. (If the EIS company has a property management subsidiary that must be at least a 90 per cent subsidiary.)

• Must be a 'small company'. The measure of whether a company is 'small' is the Gross Assets Test. The Gross Assets of the company – or of the whole group if it is the parent of a group – cannot exceed £7 million immediately before any share issue and £8 million immediately after that issue. VCM15100 and Statement of Practice 2/06 explain how assets are valued for the purpose of this test.

• Must have fewer than 50 full-time employees (or their equivalents) at the time the shares are issued.

• Can be either a company carrying on the qualifying trade, or the parent company of a trading group. The trade can be carried on either by the company issuing the shares or a subsidiary, but if it is carried on by a subsidiary, it must be at least a 90 per cent subsidiary.

The rules regarding not being controlled by another company, qualifying subsidiaries and the company carrying on the trade must be met throughout the period outlined in Part 1. If they are not, then the investors will lose their reliefs.

2.2 Limit on money raised

Companies are not allowed to raise more than £2 million in any 12 month period from the three venture capital schemes. The three schemes are the EIS, the Corporate Venturing Scheme (CVS) and Venture Capital Trusts (VCTs), Investments from any or all of these schemes must fall within the £2 million limit.

If any share issue breaks that limit, none of the investors in that issue will be able to claim any of the EIS tax reliefs.

2.3 How and when money raised by the share issue must be used

The money raised by the share issue can be used either for the purpose of an existing qualifying trade or for the purpose of preparing to carry on such a trade, providing the trade, or the preparation for it, is carried on wholly or mainly in the UK. If the company is preparing to trade, the trade must start within two years of the shares being issued.

Alternatively it can be used to carry on research and development intended to lead to such a qualifying trade being carried on.

The money raised by the share issue must also be employed for the purposes of the trade or research and development within two years of the shares being issued (or within two years of the trade commencing, if that is later).

If these requirements are not met then the investors will not be eligible for relief on the cost of their shares, and any relief given will be withdrawn. It is therefore important that companies do not raise money under the EIS unless they are reasonably confident of meeting these requirements.

2.4 Trading Activities

The trade must be conducted on a commercial basis with a view to the realisation of profits.

Most trades qualify, but some do not. Those that do not are termed 'excluded activities' and are:

• dealing in land, in commodities or futures in shares, securities or other financial instruments
• dealing in goods, other than in an ordinary trade of retail or wholesale distribution
• financial activities such as banking, insurance, money-lending, debt-factoring, hire-purchase financing or any other financial activities
• leasing or letting assets on hire, except in the case of certain ship-chartering activities
• eceiving royalties or licence fees (though if these arise from the exploitation of an intangible asset which the company itself has created, that is not an excluded activity)
• providing legal or accountancy services
• property development
• farming or market gardening
• holding, managing or occupying woodlands, any other forestry activities or timber production
• shipbuilding
• coal production
• steel production
• operating or managing hotels or comparable establishments or managing property used as an hotel or comparable establishment
• operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home
• providing services to another person where that person’s trade consists, to a substantial extent, of excluded activities, and the person controlling that trade also controls the company providing the services

A company can carry on some excluded activities, but these must not be 'substantial' part of the company’s trade. HMRC take 'substantial' to mean more than 20 per cent of the company’s activities.

Although there is no requirement that the qualifying company is resident in the UK, the trade for which the money has been raised must be carried on wholly or mainly in the UK.

If the company fails to meet these requirements throughout the period referred to at 1.2.1, relief will be withdrawn from investors.

Please note that companies that have raised money under the Scheme are required by law to inform their Small Company Enterprise Centre (SCEC) office (see 2.5 below) if they fail to meet any of the above requirements, or an investor 'receives value' (see Part 1) from the company or an associate, within 60 days of the event which led to that failure.

2.5 How a company qualifies

The EIS is administered in HMRC by the SCEC – see contact details at the end of this guide.

The SCEC decides if a company and a share issue qualifies. If they do, the SCEC then takes responsibility for checking the accounts etc of the company to ensure that it continues to meet the requirements of the Scheme.

The SCEC also operates an advance assurance scheme, whereby companies can submit their plans to raise money, details of their structure and trade etc. before the shares are issued, and the SCEC will advise on whether or not the proposed issue is likely to qualify. Guidance on what kind of information the SCEC need to consider an application for an advance assurance can be found at VCM21020.

Companies are not required to obtain such an assurance, but companies, particularly those using the EIS for the first time, may consider it prudent to do so. It gives an opportunity to spot any problems before shares are issued, and an assurance from the SCEC is also useful for companies to show to potential investors.

Once the shares are issued – irrespective of whether or not an advance assurance has been given – the company has to complete form EIS1 and send it to the SCEC. This form can be got from the SCEC, or downloaded from the HMRC website. A separate form EIS1 must be submitted for each share issue.

Please note that a form EIS1 cannot be accepted by the SCEC unless the company has been trading for at least four months. And it also cannot be accepted if it submitted later than two years after the end of the year of assessment in which the shares were issued (or two years after the end of the four month period if that is after the end of that year of assessment).

If the SCEC accepts that the company, its trade, and the shares all meet the requirements of the Scheme, it will issue a form EIS2 to that effect, and supply sufficient forms EIS3 for the company to send to the investors so they can claim tax relief (see Part 1).

This process is repeated each time a company issues shares which it wishes to attract EIS reliefs for investors.

Additional sources of information

The specialist staff at the SCEC are available to give advice on the workings of the Scheme. Their contact details are:

Small Company Enterprise Centre (Admin team)

1st Floor

Ferrers House

Castle Meadow Road

Nottingham

NG2 1BB

Telephone number: 0115 974 1250

Fax : 0115 974 2954

Email: enterprise.centre@hmrc.gsi.gov.uk

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The Enterprise Investment Scheme Association (EISA), whose members are accountants and lawyers advising EIS companies and investors, may also be able to advise. Please note however that they cannot match companies and investors.

Their contact details are:

EISA

Apsley House,

176 Upper Richmond Road, London SW15 2SH
Tel: 020 8870 0883
 

www.eisa.org.uk