Enterprise Investment Scheme checklist (or why you won’t qualify for EIS relief)

Employees and directors

Employees cannot qualify for the relief unless they are directors.  Directors can qualify if they are unpaid (with no entitlement to be paid), or paid reasonably, and have never been connected with the company or its trade prior to investing.

Existing shareholders

Existing shareholders cannot generally qualify unless all their existing shares attracted relief under the EIS, SEIS (Seed Enterprise Investment Scheme) or Social Investment Tax Relief scheme (although subscriber shares are ignored).

Maximum shareholding

Investors cannot qualify if they have more than 30% of the votes of the company, or its ordinary or issued shares, if they have an entitlement to more than 30% of its assets available for distribution, or if they can control how the company is run. The holding of an associate is aggregated with the investor’s holding for these purposes.

Borrowing by investor

An investor cannot claim relief if they have borrowed money and the lender would not have offered funds on the same terms in the absence of the investment in shares – eg if the investor borrows to fund the investment and charges the shares to the lender, EIS relief will probably not be available.

The shares

EIS relief cannot be claimed if the shares are not ordinary shares, have certain preferential rights, are issued for non-cash consideration, or are not fully paid up on issue.

The purpose of the issue

The shares must be issued in order to raise money for a qualifying business activity so as to promote business growth and development.  Converting a loan into shares will not qualify and advancing funds to the company without an advance subscription agreement may not qualify because the share issue will not raise any new money. The requirement that the money raised be used for the growth and development of the business means that share issues to raise money to acquire an existing business will not qualify for EIS relief; neither will issues which raise money to meet existing day to day expenditure. Share issues used to repay existing loan financing are unlikely to qualify. 
  

Qualifying business activity

For the purpose of the above requirement, a qualifying business activity is, at the date of issue of the shares, either carrying on a trade, preparing to carry on a trade which is carried on within two years, or carrying on research and development from which it is intended to carry on a trade. The qualifying business activity must be carried on by the issuing company or a 90% subsidiary.

Long term growth and development

Additionally, the company must have objectives to grow and develop over the long term. HMRC has indicated that ‘the long term’ here means more than the three year minimum EIS holding period – so a plan to trade for three years and then sell the business would not satisfy this requirement. The plan has to be to increase such things as revenues, the customer base, and number of employees after the initial three year period. This and the immediately following condition are referred to as the ‘risk to capital’ conditions and HMRC will not give any advance assurances if they are not likely to be met.

Risk of loss of capital

The investment must carry a significant risk that the investor will lose more capital than they gain as a return (including any tax relief). So, if the funds are used to buy an asset which is likely to retain much of its value regardless of the success of the trade, EIS relief may be unavailable.

Financial difficulty

The company must not be in financial difficulty when the investment is made. 

Trading requirement

The activities of the company or group must not consist of more than 20% of non-qualifying activities, ie carrying on non-trading activities or non-qualifying trades, for example: dealing in land, commodities, futures, shares, etc; banking, insurance or other financial activities; leasing or letting or receiving royalties or licence fees; providing legal or accountancy fees; property development; or operating hotels, guest houses, etc or nursing or residential care homes. However, royalties and licence fees from IP created by the company or group itself are treated as arising from a qualifying trade.

UK permanent establishment

The company issuing the shares must have a ‘permanent establishment’ in the UK when the shares are issued (and for the next three years) – generally this means the issuing company must have an office in the UK through which business is conducted or a UK agency. Note that it is not sufficient for another group company to have a UK permanent establishment.

Use of money

All of the money raised must generally be used within two years.

Minimum period

The trade or research and development must be carried on for at least four months, except where the company is wound up for genuine commercial reasons.

Unquoted

The company must not, at the issue date, be listed on a recognised stock exchange (other than AIM or most PLUS markets) and no arrangements must exist at that date for such a listing.

Independence

The company must not be a 51% (ie >50%) subsidiary or under the control of another company.

Subsidiaries and controlled companies

The company must not control another company, other than 51% subsidiaries which are not under the control of another person. There must be no arrangements to sell any subsidiary other than for commercial reasons. The company must not have a property managing subsidiary other than a 90% subsidiary.

Gross assets

The gross assets of the company or group (ignoring liabilities) must not exceed £15 million before, or £16 million after the EIS issue.

Number of employees

The company or group must have fewer than 500 full-time employees (or their equivalents) for a ‘knowledge-intensive company’ and fewer than 250 for other companies. 

No disqualifying arrangements

There must be no arrangements for the company to make payments to the investor or anyone connected with the investor, and no arrangements to split the business artificially in order to fit within the EIS conditions, etc.

No pre-arranged exits, protection, etc.

There must be no arrangements for sale of the shares or the business, or for the trade to cease, and no arrangements to protect the investor against the risk of making a loss on the shares.

No tax avoidance

The shares must be subscribed for by the investor and issued by the company for genuine commercial purposes and not for the purpose of tax avoidance.

Maximum amounts

The company can only issue £12 million EIS shares in total (£20 million for a ‘knowledge-intensive company’). The company can only issue £5 million of shares in the 12 months up to the date of issue which attract EIS, SEIS, VCT or Social Investment Tax Relief (£10 million for a ‘knowledge-intensive company’). These limits include investments which qualify as state aid, including R&D relief under the SME scheme and grant funding.

Maximum age

The shares must be issued within seven years of the first commercial sale made by the company or group, though this period is extended in various circumstances.