Tax efficient ways to attract inward investment into your business
Making the most of tax advantageous venture capital schemes to attract business investment
The UK has attractive start-up investment tax relief schemes, including the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS).
These provide investors with up to 80% protection, taken as a tax relief on your income tax bill, against an investment made into a UK start-up.
Why do these schemes exist?
Essentially, they are there to help businesses raise funds by reducing the investor’s risk. They do this by offering the investor tax relief.
EIS was introduced in 1994 as the successor to the Business Expansion Scheme. The Seed Enterprise Investment Scheme (SEIS) debuted in 2012, to attract investors to start-ups that may have otherwise have been viewed as too risky - rightly or wrongly.
EIS and SEIS are two of four venture capital schemes. The other two are Venture Capital Trusts (VCTs) and Social Investment Tax Relief (SITR).
Her Majesty’s Revenue & Customs (HMRC) stresses it is important to check which one is appropriate both from a company and an investment point of view.
In this article, I am focusing on only SEIS and EIS.
What’s the difference between SEIS and EIS?
SEIS is designed to help a company raise money when it is starting to trade, or one that has been trading for less than two years, whereas EIS helps an early-stage company raise funds to help grow the business.
Businesses raising money under SEIS can receive a maximum of £150,000 through the scheme, offering private investors 50% up front tax relief – hugely attractive although the amount of investment is relatively small.
The businesses must have assets of no more than £200,000 and have fewer than 25 employees.
The company must be based in the UK. HMRC says proof of a company’s permanent establishment in the UK includes having an office of factory or one of the following:
- a place of management
- a branch
- a workshop
- a quarry, mine, oil or gas well
- a building site, such as a construction or installation project
This is not an exhaustive list, but the type of business a company carries out will be the deciding factor in what premises and facilities are required to meet the conditions for investment.
EIS is for those seeking funding of up to £5m and gives investors 30% upfront tax relief and must have less than £15m of assets and up to 250 employees and therefore is open to far more companies than SEIS.
The same qualifying factors on UK residency above apply. Companies cannot raise more than £5m each year and more than £12m in their lifetime, from the four venture capital schemes that currently exist. Individuals cannot invest more than £1m each year.
Any gains from SEIS and EIS investment are 100% exempt from inheritance tax, capital gains tax and income tax.
HMRC stresses that tax reliefs will be withheld or withdrawn from investors if companies do not follow the rules for at least three years after the investment is made.
What’s the difference between ‘approved’ and ‘unapproved’?
Two types of fund invest in companies seeking SEIS and EIS money – HMRC “approved” and HMRC “unapproved”. Both spread the risk over numerous companies which is important.
Unapproved does not mean the fund is dodgy. All it means is that HMRC has not given its structure prior approval. Approved does not mean “protected” or that HMRC has approved the quality of the investments – but there are tax planning differences between the two.
With approved funds the ability exists to “carry back” for income tax relief purposes and treat the investment as if it had been undertaken in the previous tax year.
Money raised by a new share issue must be spent within two years of the investment or, if later, the date the company started trading.
It must be used to grow or develop the business and must not be used to buy all or part of another business.
Will my company qualify for SEIS or EIS?
Most trades qualify but there are exceptions if most of a trade includes coal or steel production, for example, farming or market gardening, leasing activities, legal or financial services, property development, running a hotel or nursing home, and electricity, heat, gas or fuel generation.
Apart from being established in the UK, they must not be trading on a recognised stock exchange at the time of the share issue and they must not have any arrangements in place to become quoted.
For start-ups, SEIS is an attractive way to target much needed funding. Just because a company has availed of SEIS funding does not mean it cannot go on to raise further funding from an EIS, although the amount it can raise from this will be reduced to up to £4.85m.
Companies raising money under EIS must do so within the first seven years of its first commercial sales. If you did not receive investment within the first seven years, or now want to raise money for a different activity from a previous investment, you will have to show that the money is required to enter a completely new product market or a new geographic market and that the money you are seeking is at least 50% of the company’s average annual turnover for the last five years.
What are the practicalities of SEIS and EIS?
If you are an investor, you have to source the entity or entities you are going to invest in which you might do through a trusted fund manager, or you might find a corporate finance house that has an opportunity.
You would need to get out into the market and network, and identify what it is you would like to invest in. Investors need to look at the investments and make sure they are sound. It is all too easy to get distracted by the tax relief. The tax relief is great to have; it is obviously hugely advantageous. But what is the point of tax relief if the investment is rubbish?
The business still has to have the necessary fundamentals. You still have to assess it. Is the management team any good? Are the businesses you are investing in worth it? Remember it is your cash you are going to have to invest. The tax relief should not blind you to good common-sense investment practice.
If you are a company seeking investment, you have got to get a specialist tax adviser to help you acquire the necessary approval to do so, the tax relief accreditation letter and advance assurance.
You have either got to market it through a fund manager or a corporate finance house to high-net-worth individuals who are qualified to look at it.
There are various platforms people use to market investment in their companies – not crowdfunding ones, however. For most of the EIS opportunities you need an introducer or specialist finance companies that will manage everything and probably have a roster of companies for which they want to raise money.
You must complete a separate application for each share issue and if your application is successful, HMRC will confirm the decision and send you compliance certificates to give to your investors.
Your investors cannot claim the tax relief until they receive their compliance certificate.
Do these schemes actually work?
Both schemes are success stories. The latest available HMRC statistics show that since EIS was introduced, 26,355 companies have received investment and almost £16.2bn of funds have been raised.
In 2015-16, 3,470 companies raised a total of £1.89bn of funds under EIS and in 2014-15, 3,370 firms raised £1.92bn of funds.
London and the South East accounted for the largest proportion of investment. Companies registered in these regions received 67% of investment in 2015-16.
In 2015-16, 2,360 companies received investment through SEIS and £180m of funds were raised – similar to 2014-15, when 2,365 companies raised a total of £180m.
More than 1,800 of these companies raised funds under SEIS for the first time in 2015-16, representing £154m in investment.
The HMRC statistics show that in 2015-16, companies from the hi-tech and business services sector made up 68% of the amount of SIES investment received.
What other venture capital schemes are available?
Social Investment Tax Relief (SITR) allows individuals to claim relief on £1m of annual investment and provides 30% of income tax relief.
VCTs allow an annual investment of £200,000 on which they can claim 30% tax relief. With VCTs no tax is payable on dividends where it is on SITR, SEIS and EIS.
Investors can get capital gains tax relief on any profits they make under all four of the schemes.
With SITR there is also the option to invest through a debt instrument.
The rules of VCTs might be a little complex to navigate for both company and investor if new to these kinds of arrangements.
These schemes are attractive and can help a company attract investment and an investor mitigate some of their risk – but it is easy to come unstuck. Therefore, whether you are looking to invest or looking to raise funds, it is advisable to seek expert guidance to help you through the process.
Clive Hyman, Chairman and CEO, Hyman Capital