EIS guide

17 16 RISKS AND REWARDS RISKS AND REWARDS Since the loss relief is being applied to capital gains charged at 20%, the client can claim 20% of the loss, a total of £2,000 (£10,000 x 20%) against their CGT liability in the year of the loss or any future capital gains. Example 2 (Loss relief - total loss) Another client invests £100,000 in EIS qualifying companies. By doing so, they are entitled to reduce their income tax liability by a maximum of £30,000 (30% of £100,000). The net cash cost of investment is then £70,000. If all the investments failed, the total loss before loss relief would be £70,000. In the event of total loss, the amount of loss relief that can be claimed is dependent on the investor’s marginal rate of income tax. (The investor wants to offset the loss against other income taxable at 45% as opposed to chargeable gains taxed at 20%) This client pays 45% income tax and can claim 45% of the loss, a total of £31,500 (£70,000 x 45%) against their income tax liability. This means they have received tax reliefs totaling £61,500 against their £100,000 investment, limiting their exposure to 38.5% of the original investment. If the entire loss cannot be relieved against income in the relevant two years (perhaps because there is not enough income to relieve the losses fully), any unused balance can be used against capital gains arising in the same year as the loss; or carried forward to offset against any future capital gains. Other loss reliefs that can be set against income, such as trade loss relief, are restricted to the higher of £50,000 or 25% of the taxpayer’s income annually. However, this restriction does not apply to EIS, where EIS income tax relief is claimed (but it does apply where only CGT Deferral Relief is claimed). Options for offsetting losses on EIS shares Against Capital Gains As with conventional capital losses, any losses from the sale of EIS-qualifying shares can be offset against any capital gains made in the same tax year, thus reducing any CGT liability; Any remaining losses can be carried forward to a future tax year; Any income tax relief received in relation to the initial investment is subtracted from the capital loss first. Against Income The loss can be offset against any income in either the same tax year or the preceding tax year, or both; The loss is subtracted from the investor's net income when calculating their income tax liability; Any income tax relief received in relation to the initial investment is subtracted from the capital loss; In practice, as income tax rates are usually higher than CGT rates, offsetting against income tax will generally be more attractive where a client is subject to the higher rates of income tax. It’s been no secret that the recent changes to the EIS and VCT legislation have had a huge impact on the ability of companies in the film and media sector to access EIS and VCT financing, leading to several high profile EIS media fund closures. Coupled with the ongoing HMRC disputes into film production companies, it’s been tough for the sector, particularly for small independent film production companies seeking to raise external finance. So why have the recent EIS changes made life so difficult for film and media companies compared with other sectors? Historically, companies would raise money under EIS using special purpose vehicles (SPVs), which would then be used to finance specific film or other sector-focused projects. The SPVs would have a minimal organisational structure, and most of the costs of production would be incurred via contractors and third parties as is the norm for the sector. Once the project was completed, the SPV would be wound up and any profits would be distributed to financiers and investors. It’s obvious therefore to see how this model struggles to satisfy a key element of the risk-to- capital condition: the need to evidence objectives to grow and develop a trade for the long term. EIS funds and film and media companies have had to adjust their investment strategy to focus on investing in an underlying business rather than specific projects in order to operate within the new rules. Some of the key areas where they’ve had to adjust include: • Investment in companies responsible for multiple projects which are seeking to build an IP library which they have produced and own, with profits and capital reinvested back in the company for the future. A pipeline of future projects which support a long-term growth proposition is key. • EIS money being employed for the growth and development of the business, such as the recruitment of new staff, building a sales team or infrastructure to support future growth. That does not preclude the use of contractors, particularly where this is an industry norm, however HMRC wants evidence of real organisational growth through increased head count, revenues and customers. • Projects may still be undertaken in SPVs but these must be wholly owned subsidiaries of the EIS investee company which itself retains creative and operational control of both the company and project. While HMRC’s guidance indicates that EIS funds can be used to fund ‘project activity’, in practice we see HMRC taking a different stance and refusing to accept that project costs can be funded with EIS investment. As a result of the sector adapting, we have seen an increase in the number of advance assurances provided by HMRC. Furthermore, a new BFI- backed EIS fund has been created specifically for investing in the creative industries and is hoping to raise £20 million in the first year alone. All in all, funding prospects for EIS-backed media businesses look much rosier now. FILM AND MEDIA FUNDS IN EIS - WHY THE WRULE CHANGES CAUSED THEM PROBLEMS Thought Leadership DAVID ADAMS SENIOR MANAGER, GRANT THORNTON LIZ BRION PARTNER, GRANT THORNTON