EIS LEGISLATION

The Enterprise Investment Scheme (EIS) was introduced in 1994 to encourage individuals to invest in small higher-risk trading companies as a means to help alleviate the problems faced by such companies in raising equity finance. The scheme provides income tax relief for new equity investment for qualifying investors in qualifying unquoted companies, and capital gains tax exemption on disposal of shares.

Full details can be found in the Inland Revenue IR137 pamphlet on EIS .

There are significant tax advantages to be obtained for individuals making EIS Investments. Click on FAQ's for some examples of AVAILABLE TAX RELIEF

  Summary of EIS legislation

This is a summary of the main provisions of the Enterprise Investment Scheme so far as relevant to the Company as set out in Section 289 and subsequent sections of ICTA 1988, Schedule 5B of TCGA 1992, and other relevant legislation. It does not set out any of the provisions in full and intending Investors are strongly advised to seek professional advice as to the tax relief that their particular investment will attract and the tax consequences of selling or otherwise disposing of their shares.

Basic rules

The reliefs can only be claimed by an individual, or, for Capital Gains Deferral Relief, certain trustees, who subscribe for new eligible shares in a qualifying company. 'Eligible Shares' are ordinary shares which carry no preferential rights to dividends or to assets on a winding up, and no rights of redemption.

Income tax relief for subscriptions

Income tax relief is available to individuals in respect of the amount subscribed for eligible shares in a qualifying company at 20%, up to a maximum of 20% of £400,000 for the Tax Year 2006/7. Where income is insufficient to obtain relief at 20%, relief will be given to the extent it reduces the tax liability to nil.

Capital gains deferral relief for subscriptions

A claim may be made to defer the assessment of any chargeable gain, or any part of such a gain, which arises within the period of three years before or one year after the issue of eligible shares in a qualifying company. The gain, up to the amount subscribed for those shares, may be deferred until the shares are disposed of or, if earlier, until certain other events occur.

The investment process

The subscription for the shares must be fully paid, in cash, at the time the shares are issued. The shares, and all other shares issued on the same day, must be issued for the purpose of raising money for a qualifying business activity.

At least 80% of all money raised by the issue of shares on that date must be employed by the investee company for the purpose of a qualifying business activity within 12 months, or within 12 months of the start of the trade, with another 12 months to employ the remaining 20% raised.

Qualifying business activity

A qualifying business activity must be a qualifying trade, or research and development intended to result in a qualifying trade. It may be carried on either by the company or by a qualifying subsidiary, which is at least 90% owned, but the trade must be carried on wholly or mainly in the United Kingdom.

Basic rules - Income tax relief

Income tax relief can only be claimed by an individual eligible for relief. To be eligible an individual must not (with one exception, mentioned below) be connected with the company either before the shares are issued or within three years of the issue of the shares (or of the commencement of trade, if later).

An individual is, broadly, connected with a company:

a) if he or an associate of his is an employee, partner or paid director of the company, or

b) if he and/or an associate possesses, or is entitled to acquire, more than 30% of the issued ordinary share capital, or loan capital and issued share capital, or voting power in the company. (This does not apply, subject to certain conditions, where the only shares owned are subscriber shares).

For this purpose an associate includes a husband or wife, lineal ancestor or descendant, a business partner and certain persons with whom the individual has connections through a trust.

A 'paid director' is one who receives, or is entitled to receive, any form of payment from the company other than certain items such as reimbursement of expenses allowable for tax purposes.

The exception referred to above is where at some time following the issue of the shares the individual is connected with the company, and is so connected solely by virtue of being a director of the company who is so paid for services rendered as a director or employee, but was not so connected in any way before the issue. Subject to certain conditions, such an individual is eligible for relief.

Qualifying companies

The company must initially (at the time of issue of the shares) not be quoted on the Official List of the United Kingdom Listing Authority and there must be no 'arrangements' in place for it to become so quoted. In addition, throughout the relevant period (commencing with the issue of shares and ending three years later or three years from commencement of trade, if later), it must not be a subsidiary of, or be controlled by, another company; it must either exist to carry on a qualifying trade or else be the parent company of a trading group; and there must be no 'arrangements' in existence for the company to become a subsidiary of, or be controlled by, another company.

A trading group is a group in which at least 51% of the shares of each subsidiary are held by another member of the group, but any subsidiary employing any of the money raised by the issue must be 90% owned. Non-qualifying activities (broadly, investment activities and non-qualifying trades) must not comprise a substantial part of the business of the group as a whole.

The value of the gross assets of the company and any subsidiaries must not exceed £7 million immediately before the issue and £8 million immediately after it.

The Directors have undertaken, so far as it is within their power to do so, to ensure that the Company's affairs will be conducted so as to obtain and maintain qualifying status under the EIS throughout the relevant period.

Qualifying trades

Most types of trades qualify, but the following are excluded:

a) dealing in land, commodities or futures, or in shares, securities or other financial instruments;

b) dealing in goods otherwise than in the course of an ordinary trade of wholesale or retail distribution, or acting as a wholesaler or retailer of goods of a kind which are collected or held as investments if stock is not actively sold;

c) banking, insurance, money lending, debt factoring, hire purchase financing or other financial activities;

d) leasing (except certain lettings of ships) or receiving royalties or license fees ( subject to certain exceptional cases which include receiving royalties and licence fees from films);

e) providing legal or accountancy services;

f) farming and market gardening;

g) forestry and timber production;

h) property development;

i) operating or managing hotels or similar establishments;

j) operating or managing nursing homes and residential care homes: and

k) providing services to a trade consisting of any of the above carried on by a 'connected person'.

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

  Withdrawal of reliefs

If any of the conditions relating to the company cease to be satisfied at any time beginning with the issue of shares and ending three years later, or three years from commencement of trade if this gives a longer period, the EIS income tax relief is withdrawn and /or the deferred gains come back into charge to tax, as the case may be.

Relief is also wholly or partially withdrawn and the deferred gains come back into charge if, within the three year period the claimant receives value from the company or otherwise ceases to be eligible for relief. In the case of Capital Gains Deferral Relief , the deferred gain comes back into charge on the disposal of the shares other than to a cohabiting spouse. Value is received from the company if , for example, it repurchases or redeems the shares, or makes the individual a loan or provides a benefit or facility to the individual. However in certain circumstances, 'insignificant' amounts of value (or the return of value to the company without delay) will be disregarded.

Tax avoidance

The reliefs are not available unless the shares are subscribed for, and issued, for bona fide commercial purposes and not as part of a scheme of arrangement, the main purpose of which, or one of the main purposes of which, is the avoidance of tax. There must not be any arrangements that would either secure in advance a means of realising the shares or underpin their value.

Treatment of gains & losses on disposal of shares

A gain ( other than a deferred gain which has been subject to Capital Gains Deferral Relief ) that accrues to an individual on the disposal of any shares, in respect of which EIS income tax relief has been given to that individual and not withdrawn, is not a chargeable gain for the purposes of capital gains tax. But if the disposal gives rise to a loss after taking the income tax relief into account, that net loss can be set against either income or chargeable gains.

A gain that accrues to an individual on the disposal of shares in respect of which EIS income tax relief previously given has been withdrawn, or a gain that accrues to trustees on the disposal of shares, will be a chargeable gain. In addition, any deferred gain which has been subject to Capital Gains Deferral Relief will come back into charge to tax on the disposal, in addition to the gain on the disposal of the shares themselves.

Where an investor (whether an individual or trustee) realises a loss on the disposal, such loss should be available for set off against any chargeable gain which has been the subject of Capital Gains Deferral Relief but which come back into charge to tax on such disposal.

Claims

Investors make a formal claim for EIS Relief or EIS Deferral Relief to their inspector of taxes. The claim is made on receipt of Form EIS 3 from the company. Form EIS 3 is a certificate issued by a company, with the approval of the Inland Revenue, confirming that it is a qualifying company for these purposes. A company cannot seek the Inland Revenues approval until it has carried on a qualifying activity for four months. The approval must be sought within two years of the end of the year of assessment in which the shares are issued or, if later, within two years of the period commencing with the date on which the company completed its first four months of trading. An investor's claim must be submitted to his tax inspector no later than the fifth anniversary of 31 January following the year of assessment in which the shares were issued (or treated as issued if relief is carried back).

Pre-Arranged Exits

An individual will not be eligible for EIS relief if arrangements exist for the subsequent repurchase of these shares or of securities in the Company. "Arrangements are widely drawn and includes an understanding, however informal, that the shares will be repurchased or redeemed.