Every startup and growing business needs capital to develop. Over the past two decades, the UK has developed a unique ecosystem to make it easier for emerging businesses to access that essential “seed” capital. An important part of that action has been the implementation of generous tax incentive schemes to encourage individuals to invest in early stage British companies.
Investing in early stage companies can offer large rewards, but comes with an associated high level of risk which can put off even the most sophisticated investors. These tax schemes were therefore designed to boost the return potential of early stage investments and provide downside protection in case of a loss.
These tax incentives have been a resounding success with more than 30,000 companies benefiting from them and receiving every year over £1.6bn worth of investment under the schemes.
So what are these schemes, how do they work and what makes them so attractive – this is what we will try to explain in this article!
The first scheme to be launched was the Enterprise Investment Scheme (EIS). The UK government introduced it in 1994 to boost investments in private companies by offering generous income and capital gain tax reliefs to private individual investors.
Over 26,000 companies received funding under EIS amounting to a total of £15.9 billion, according to HMRC’s latest progress report from April 2017. The popularity of the scheme is still very high with almost half of the companies which succeeded in raising EIS funding in 2015/2016 doing so for the very first time.
Following the success of the EIS, the government decided in 2012 to go one step further to help the youngest (and riskiest) companies to also receive investment. A new scheme called the Seed Enterprise Investment Scheme (SEIS) was introduced. The SEIS is basically the little brother of the EIS: it works in a similar way, but focuses on the youngest companies and provides even more generous tax reliefs to investors.
Despite only celebrating its fifth anniversary, SEIS has also proven to be success: since 2012, 6,515 young companies have received a total of £608 million under SEIS. The scheme has been a key driver of the entrepreneurial boom that we are currently witnessing in the UK as it allows entrepreneurs to accelerate the first stages of building their company.
In order to qualify for the SEIS and EIS investment schemes, a business has to be UK registered and operate a “qualifying trade” (anything apart from things like property development, legal or financial services etc.).
Businesses also have to show that they are young, small to medium size companies. A company has to have less than 250 employees and less than £15m of gross assets to qualify for EIS. Requirements are stricter for SEIS which was designed specifically for startup companies: companies have to have been trading for less than 2 years, have less than 25 employees and less than £200k of gross assets. SEIS qualified businesses will typically be at their early stage, sometimes pre-revenue and therefore quite risky for investors. Businesses can raise up to £150,000 under SEIS only which the cap on EIS is £5m.
Businesses can apply to HRMC for pre-clearance and receive an “advance assurance” letter which confirms their SEIS/EIS eligibility (but does not guarantee it). Entrepreneurs always must make sure that they still meet all the criteria before accepting any investment and should work with competent accountants who can help them navigate the rules as HRMC will take a deeper look into the business and the investment when the company requests the SEIS and EIS certificates on behalf of its investors. This tax benefit is only available for an issue of ordinary shares which does not give investors any preferential rights.
These are the main tax benefits for investors.
• Income Tax Relief
The main attraction of these schemes is the income tax relief that investors receive on their investment: under EIS, qualifying investors receive 30% of their investment back from HMRC against their income tax bill. Every year, they can invest up to £1,000,000 under the scheme and receive up to £300,000 back from the tax man.
The relief is even higher in the case of SEIS as HMRC will pay back 50% of the investment against the income tax paid up to a maximum investment of £100,000 per year.
• Capital Gain Tax Exemption
The second attraction is that investors will not pay any capital gain tax on disposal of their SEIS or EIS investments, provided they have held the shares for at least three years.
• Loss Relief
In case the investment fails and the company is liquidated, investors are eligible for a loss relief in the form of a “loss relief” of up to 22.5% or 31.5% of their initial investment for SEIS and EIS respectively.
This means that between the Income Tax and Loss reliefs, high rate taxpayers investors only risk to lose 27.5% of their investment under SEIS and 38.5% under EIS. This is a huge downside protection provided by HMRC.
SEIS and EIS also offers a range of additional tax benefits which can be attractive depending on your situation such as a CGT Reinvestment Tax Relief, CGT Tax Deferral and Inheritance Tax Relief.
RECEIVING THE TAX BENEFITS
In order for investors to claim these tax benefits, the company that received their investment will need to contact HMRC and provide its investors with a certificate allowing them to claim the reliefs themselves directly via their Self-Assessment Return. Investors should be aware that this process can take up to 6 months after their investment.
It is important to mention that the tax benefits depend on your personal circumstances and so all investors are always advised to seek professional advice!