EIS guide

27 26 RULES FOR INVESTORS AND QUALIFYING COMPANIES RULES FOR INVESTORS AND QUALIFYING COMPANIES Qualifying companies In order to ensure that EIS is meeting its objective of financing small to medium-sized businesses that might otherwise struggle to obtain investment from other sources, there are stringent criteria that govern whether a company and its proposed share issue qualifies for the EIS reliefs. These criteria change from time to time. This section sets out the rules as they stand today and also details some of the most recent changes. Risk-to-capital condition Announced at the Autumn Budget 2017, the risk-to-capital condition applies to all investments made on or after Royal Assent of the Finance Act 2018 on 15 March 2018. However, HMRC has applied the test for all EIS advance assurance applications submitted from December 2017. From this point, HMRC has declined to provide advance assurances for investments that, taking into account all the facts available to them, appear likely to fail the risk-to-capital condition. The government is keen to stress that the Venture Capital Schemes are intended to support early-stage, entrepreneurial companies that have the potential to grow in the long term. The company must be set up to carry out trade on an ongoing basis, not to carry out a single project before being wound up. Following the government’s 2017 consultation, ’Financing growth in innovative firms’, the enactment of the 2018 Finance Bill on 15 March 2019 saw the introduction of new conditions. These are intended to exclude tax-motivated investments, where the tax relief provides most of the return for an investor or with a limited risk to the original investment (that is, preserving an investor’s capital). The risk-to-capital condition depends on HMRC taking a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors. The condition has TWO parts: 1. Whether the company has objectives to grow and develop over the long term (which broadly mirrors an existing test with the schemes); and 2. Whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return. The condition requires all relevant factors about the investment to be considered in the round. The legislation contains a non-exhaustive list of the factors that may be considered. Even if one or more indicators of potential capital preservation are present, this does not necessarily mean that the risk-to-capital condition will not be met in a particular case. A judgement about whether capital preservation activity is taking place will depend on the overall context of the investment. Likewise, even if none of the indicators listed in the legislation are present, the risk-to- capital condition may NOT be met if the wider circumstances of a case suggest that capital preservation is taking place. Ultimately, a judgement will depend on the level of risk posed to investors’ capital and whether the company has genuine intent to grow and develop in the long term. Following Royal Assent of the Finance Act 2018 on 15 March 2018, the new risk-to-capital Examples of non-qualifying companies Example 1 In 2013, EIS manager A invested clients in a company that was constructing and operating a solar-photovoltaic farm. This would no longer be a qualifying investment for an EIS portfolio, as energy generation activities no longer qualify. Example 2 In 2013, EIS manager B invested clients in a company that was undergoing a Management Buyout (MBO) and the EIS funds were being used to acquire the shares of exiting management. This would no longer be a qualifying investment for EIS as EIS funds can no longer be used to acquire part of an existing business*. Example 3 In 2015, EIS manager C invested in a company that was established to operate, through subcontractors, a pub. Certain factors indicated a capital preservation strategy. This would no longer be a qualifying investment for EIS as it is unlikely to qualify under the ‘Risk-to-capital’ conditions introduced for all EIS and VCT investments made on or after 15 March 2018*. The growth and development of your company should be permanent and not rely on the investor’s continued support. HMRC *See page 33 for a summary of the changes announced in 2015 and 2017. condition will sit above the other existing eligibility requirements for the venture capital schemes. Even if the new condition is met, all other requirements must also be met for an investment to be eligible for tax relief under the schemes.