EIS guide

23 RULES FOR INVESTORS AND QUALIFYING COMPANIES Investors As well as a number of conditions that must be met by the EIS company itself during the relevant investment period, there are some rules that investors in EIS-qualifying shares must adhere to if they are to receive and maintain the full benefits of the reliefs available. Some of these have been covered in other sections, and they are set out in more detail here. The overarching criteria is that the investor should have an appropriate tax liability or a potential tax liability that they wish to offset and/or defer: • Either an income tax liability or potential income tax liability in the tax year of the Investments into unquoted small and medium- sized enterprises are deemed high risk. It is important to understand the risks associated with EIS-qualifying investments in a general sense, and we will examine some of those risks here. However, each individual EIS investment opportunity has its own unique risks and, therefore, each opportunity must be individually assessed. Rules for investors and qualifying companies prospective EIS share issue, or the prior tax year if carry back is available (in order to claim the EIS income tax relief and potentially qualify for disposal relief). • A CGT liability or a potential CGT liability in the relevant period (in order to claim CGT deferral relief where relevant). • A potential IHT liability (in order to qualify for BR, subject to a minimum holding period). Minimum holding periods Investors must hold the shares for a minimum of three years in order to qualify for income tax relief and disposal relief (where the shares are disposed of at a profit). Any disposal of the shares (excluding a transfer between spouses) prior to the end of the minimum three-year period leads to HMRC clawing back some or all of any income tax relief. Any deferred capital gains are also crystallised on disposal (although this is the case whether the shares are disposed of before or after the expiration of the minimum three-year period, to the extent that a further EIS investment isn’t made to further defer the crystallised gains). The minimum holding period starts from the acquisition date of the shares (if the company is not trading when the shares are issued, the period ends on the third anniversary of commencement of the trade). Research and Development (if that is the qualifying business activity of the EIS company) is considered ‘trading’ for these purposes. For IHT purposes, investors must hold the shares for a minimum of two years from the later of the issue of the shares or the commencement of the trade, in order to qualify for IHT relief via BR (unless the investment counts as ‘replacement business property’). Connected parties In order to obtain the maximum tax relief, the investor (or any ‘associate’ of theirs) must NOT have a connection with the company at any time in the period from two years before, to the later of three years after the investment was made and the date the company commences trading. An individual is connected if he or she, whether alone or together with any ‘associate’ (associates can be business partners, spouses and civil partners, parents, grandparents, children and grandchildren), directly or indirectly possesses or is entitled to acquire: • More than 30% of the ordinary share capital of the company; • A right to more than 30% of the income, or they can otherwise control the company; • More than 30% of the assets in the event of the company winding up (this assessment includes any loans made to the company); • More than 30% of the voting rights in the company. These conditions also apply to any ‘follow on’ investment: for example, if an investor already has a 20% stake in a company, and then subscribes for an additional 15% stake, they breach the ‘30% test’. If the second investment is made within the minimum three-year holding period for the first investment, income tax relief would be withdrawn in respect of the first investment. There is an exception to the ‘Connected Parties’ test for ‘business angels’, who are directors with no previous connection to the company prior to investing. If they subsequently become a paid director of the EIS company, and provided that the remuneration is reasonable, the relief is not withdrawn. Any director involved in the EIS company’s trade prior to the share issue is likely to be connected and relief will be denied. There is also the ”Independent Investor” requirement. This says that at the time of the share issue, if the investor holds other shares in the company for which SEIS or EIS income tax relief cannot be claimed, then the new share issue does not qualify either. The only exception is if the existing shares are ‘subscriber shares’ issued to the individual when the company was founded or the shares were acquired when a pre-formed dormant company was bought ‘off the shelf’. EIS investee companies Connected parties EIS income tax relief is restricted for individuals who are employees of the investee company, or who are ‘associated’ with such employees or they are a business partner, spouse, civil partner, parent, grandparent or child of an investor where alone or together, they have: 30%+ of assets if company winds up 30%+ of voting rights 30%+ of income rights Existing non-EIS shares in the company (other than certain subscriber shares) 30%+ of ordinary shares