How older companies can qualify for EIS

This post is part of our Entrepreneurial team’s regular series of blogs.

This week I’m looking at the ways that companies can qualify for EIS despite being outside of the ‘initial investing period’. There are a few ways to do this, but there are also a number of areas to watch out for where mistakes that prevent EIS qualification can be made.

What is the initial investing period?

Broadly, the initial investing period is the seven years following a company’s first commercial sale. (Knowledge Intensive Companies (“KICs”) have more generous rules which allow them a longer initial investing period and several other relaxations: for more information see the blog my colleague Ryan wrote.)

The first commercial sale can sometimes be tricky to pin down. It’s defined in the European Commission’s Guidelines on State Aid as “the first sale by an undertaking on a product or service market, excluding limited sales to test the market”. The key point to bear in mind is the “limited sales to test the market” point, as the first time a company makes a sale (for example of a prototype) does not necessarily mean that the seven year clock to receive EIS will immediately start ticking after this.

Receiving EIS investment after the initial investing period

There are three conditions that allow companies to access EIS investments after the initial investing period – conditions A, B and C. Your company only has to meet one of these.

Condition A – past S/EIS received

Funding under condition A is available if a company has already received past S/EIS investment before the end of the initial investing period and:

  • the new EIS funding is used for the same qualifying business activities as the first S/EIS funding was; and
  • the company’s business plan at the time of the initial funding foresaw the need for follow-on funding.

It is the second condition that is a frequent issue. Where companies suspect that they will require further funding, this should always be specified in the business plan – even if the quantum of future funding required is not specifically known at that time.

(NB: where the initial S/EIS was received before 18 November 2015, the business plan does not have to show the need for follow-on funding.)

Condition B – new product or geographic market

Condition B allows companies to receive EIS funding where:

  • the amount of the EIS funding, together with any other EIS, SEIS, VCT, SITR or other Notified State Aid funding (e.g. Innovate UK or SMART Grant) within a 30-day period, is at least 50% of the company’s average annual turnover (calculated by averaging the company’s turnover for the past five years); and
  • the money raised by the EIS funding must be used for entering a new product market or geographic market).

The first test is often overlooked as companies focus on the second. It is important to note that non-EIS investment does not qualify. Scottish Investment Bank match equity funding, for example, is not a Notified State Aid and does not qualify.

As the EIS funding needs to be spent entirely on the new product or geographic activity (and companies need to show how the money will be spent), companies should not try to raise more money than they need for the new activity, as spending money on other business activities would cause them to fail the condition. On the other hand, the first part of the test may mean that companies need to raise a large investment if they have succeeded in generating significant turnover over the past few years – so it is important that companies carefully consider exactly how much EIS funding they require.

To be considered to be entering a new product market, a company must show that it is targeting a new customer base, and not just releasing a new product which its existing customers would use.

In terms of entering a new geographic market, companies need to show that the conditions of competition are appreciably different in this new area. Expanding to a new city is not likely to meet this test, but expanding to a new continent likely is.

The key point for a company to prove with relation to condition B is that it would not be possible to use its previous track record to assess the potential of success for its new activity. Companies should aim to demonstrate to HMRC that they are effectively setting up a new business, not just slowly expanding.

Condition C – past EIS funding under condition B

Condition C is, luckily, a lot simpler, and is simply for companies that have raised EIS funding under condition B and now wish to raise follow-on funding. The rules are the same as for condition A – remember the importance of specifying the need for follow-on funding in the business plan!

In Summary

Securing EIS investment after the initial investing period of 7 years may look like a daunting process, so if you think that this might apply to your company it’s best to start thinking about it sooner rather than later. That way, parts of the tests are less likely to catch you out in the future.

If you would like further advice regarding the availability of EIS relief, please get in touch with us.

EMI consultation: share your views on possible expansion

This post is part of our Entrepreneurial team’s regular series of blogs.

One of the somewhat unexpected outcomes of the Budget on 3 March was the announcement of a consultation into the Enterprise Management Incentive (“EMI”) scheme. The EMI scheme, as noted in previous blogs, is a key tool for high-growth companies in recruiting and retaining employees.

Although there were many calls from industry bodies and professionals for a consultation on the scope of the Enterprise Investment Scheme (“EIS”), the Chancellor chose instead to focus on EMI, seeking evidence on whether the scheme should be expanded and how it could be expanded to best support high-growth companies.

The consultation is open and is seeking evidence on the following points:

  • Whether the scheme currently meets it policy objective of helping companies to recruit and retain employees.
  • Whether the scheme is meeting its objective of helping SMEs grow and develop.
  • Evidence on which aspect of the scheme is most valuable in helping SMEs with their recruitment and retention objectives.

The ways in which the scheme could be expanded could result in an extension of the qualifying trade criteria regarding the type of trade undertaken by a company, or perhaps the limits relating to the value of options a company can issue or an individual can hold, or less likely, an extension of the tax advantages, for example in relation to Business Asset Disposal Relief. Currently the limit of Business Asset Disposal Relief is £1 million, in line with the reduction from £10 million to £1 million for all eligible capital gains. It appears from the consultation document that one of the key areas for potential expansion would be regarding the limits imposed.

Further, the document asks whether the other tax-advantaged share schemes offer sufficient support to high-growth companies where they no longer qualify for EMI. We have recently commented on the use of CSOP as an effective tool, however, whether this is of much use once the EMI limits have been breached is questionable. The flexibility of EMI certainly makes it the most advantageous scheme and many companies will go on to use a form of growth share scheme once the EMI limits are reached, in order to ensure the highest growth opportunity for employees.

We will, of course, be responding to the consultation and encourage businesses who have used the scheme to either respond directly with evidence or get in touch with us if they wish to feed into our response.

If you have any questions on the consultation or how to provide evidence, please contact me as I will be collating our response.

EIS: alive and KICing for companies that innovate

This post is part of our Entrepreneurial team’s regular series of blogs.

There have been many tweaks made to the Enterprise Investment Scheme (“EIS”) since its inception in 1993. Mostly, these have toughened qualifying conditions. However, seeking to advance its use in certain companies, HMRC introduced significant relaxation of several EIS limits. This relaxation of the rules was only made available to Knowledge-Intensive Companies (“KICs”), which are the types of companies in which the majority of Scottish EIS investment funds are placed. This blog will explore the benefits and qualifying requirements of being a KIC.

The benefits of being a KIC

  • A company can raise £10m EIS investment per year and £20m EIS investment over the company’s lifetime (in comparison to £5m and £12m limits, respectively, for non-KICs).
    In addition, investors can claim tax relief on up to £2m worth of EIS investment, if at least £1m of this is invested in KICs.
  • A company can receive its first EIS investment up to 10 years from the end of the accounting period in which its turnover first exceeded £200,000 (the time limit being only 7 years from first commercial sale for non-KICs).
  • A company may have a maximum of 500 full-time employees (with the maximum for non-KICs being limited to 250).

How to qualify as a KIC

To qualify as a KIC, a company must meet two conditions: the operating costs condition and either the innovation condition or the skilled employee test:

Operating costs condition

  • The company must have spent:
    • at least 15% of its operating costs on research and development or innovation in one or more of the previous three years (or in the three years following investment for a new company); OR
    • at least 10% of its operating costs on research and development or innovation in each of the previous three years (or in the three years following investment for a new company).

Innovation condition

  • the company must be carrying out work to create intellectual property and expect the majority of its income to come from this within 10 years.

Skilled employee test

  • the company must have 20% or more of its employees carrying out research for at least 3 years from the date of investment, and these employees must be in a role that requires a relevant Master’s degree or higher.

In Summary

For most technology-based or R&D companies, the KIC conditions will be relatively easy to meet. However, HMRC will only provide pre-investment assurance of KIC status through its Advance Assurance regime if a company actually requires this status in order for the investment that it receives to be EIS qualifying i.e. to get within one of the higher limits that are permitted for KICs. If the limit in question is the investor one (i.e. if any investors are relying on the company being a KIC for their own personal EIS annual investment limit), the company must provide HMRC with the investor’s details and notify them of the investor’s requirement for their investment to be in a KIC.

These rules provide hope for companies that might, due to their age, have disregarded the possibility of receiving EIS investment. If you are interested in exploring the availability of EIS, please get in touch and we can discuss further.

EIS: case update regarding dividend rights

This post is part of our Entrepreneurial team’s regular series of blogs.

To be (a preference) or not to be (a preference): that is the question. More accurately, that was the question before the Upper Tier Tribunal (UTT) last week regarding Foojit, a company whose EIS compliance statement was rejected by HMRC.

The court had to decide whether to uphold a decision made by the First Tier Tribunal (FTT) in 2019 that the right to receive 44% of dividends payable up to a limit, presumably aligned to investment delta, constituted “a preferential right to dividends” and therefore agree with HMRC. It did.

The case was intricate. Essentially, the UTT agreed with the premise of the FTT’s findings that there needed to be some deliberate action or decision on the part of the company to enable or initiate the dividend declaration. This, coupled with the clear position – accepted by both sides – that the quantum of the dividend was a preference, meant that the shares requirement for EIS compliance was not met. Interestingly, the UTT corrected the focus of all parties (including the FTT without so naming it) that it is not enough to consider the updated Articles. Rather, where there are model Articles in place, it is incumbent on the reader to consider both documents.

There is a disparity in the EIS legislation regarding preferences: the test looks at both assets and dividends and, whilst prescriptive regarding the latter, leaves the former undefined. This, coupled with HMRC’s long established, if counter-intuitive, position that rights to assets are only “preferential” if they enable one share class to receive before another share class irrespective of quantum, means that it is commonplace to award 99.99% of assets up to a hurdle to the EIS share class, so long as dividends are equal between all share classes. Note, all share classes. Users of deferred and growth share classes beware.

The UTT did provide some offer some hints at what it would have found acceptable, such as had the dividends been predetermined to be payable and then crystallise as a debt if unpaid, but I think that it would be a brave company that relies on that as offering a binding precedent.

In reality, the overwhelming majority of EIS companies will never get to be dividend paying whilst owned by the investors; successful companies will create IP and resultant large negative reserves before turning the corner and being acquired, or the less successful will fail. As such, my advice would be to lean toward pragmatism; leave dividends well alone. Don’t try to be too clever over rights that are not likely to be effective in practice. Focus on asset rights, which will make a difference to the investors rather than risk suffering the slings and arrows of outrageous fortune.

Brexit is done, so roll on amendments to EIS

This post is part of our Entrepreneurial team’s regular series of blogs.

Many within the investment industry have been frustrated at the restrictions placed on SEIS and EIS by virtue of compliance with EU legislation.

Whatever your political persuasion – this article is deliberately apolitical – it is clear that Brexit offers an opportunity for HM Treasury to make amendments to the SEIS and EIS schemes, without breaching EU law. It would appear that with this in mind, the EIS Association (EISA) has written to the Chancellor and laid out proposals to improve these schemes.

SEIS is de minimis state aid, meaning that there were limits around the quantum of investment that could be received and also that EIS is a Notified State Aid, providing the EU with influence over its rules and application.

Such influence was most notably exercised in 2015 when HM Treasury instigated changes to EIS because it needed EU reapproval of the scheme. These changes included a termination date for the EIS scheme; a maximum age of the company requirement and restrictions on which investors qualified, how money was to be spent, and which companies qualified; and the promotion of “Knowledge Intensive Companies”. With the exception of the last point, these changes were not welcomed by most and fundamentally changed the investment landscape. In my opinion, for the worse.

The EISA’s letter, timeously issued in advance of the March Budget, sets out its recommendations for changes to these schemes. I applaud their actions, having written several articles in the past stating my desire for positive and progressive post-Brexit changes to the EIS scheme. Their recommendations, together with my own thoughts, are listed below:

Immediate change – i.e. from 3 March 2020

1. Increase the maximum level of SEIS investment from £150,000 to £250,000.

The majority of start-up companies we see seeking investment look for around £250,000 in their first investment round. As the rules currently stand, investors need to seek the first £150,000 to be SEIS and the remaining £100,000 to be EIS. The effect of which, to be compliant with the SEIS rules, is that the investment must be tranched over two days. This added complexity requires more detailed and correspondingly expensive investment agreements to be drawn up, as a result of which I have seen investments falling through.

Autumn Budget changes – likely to be around mid-November

2. Replace the Age Restriction with a more appropriate threshold

5 years on, the maximum age restriction is still the EIS change that prompts the most questions to our @LINC Scotland EIS Helpdesk from investors. In a nutshell, older companies do not qualify unless

  • i) they have previously taken EIS investment and are seeking to further fund that activity; or
  • ii) are trying to do something very different and are raising a significant sum to finance it.

I see half a dozen good companies every year which need investment and cannot get through these rules. They are left out to dry. The EISA do not advocate simply throwing open the doors to all companies, but replacing this (unfair) test with a (fairer) test that reflects the size, not the age, of the business.

3. Ministerial assurances that EIS will continue beyond 2025

If we are to succeed as a country, investment in innovation is critically important. Banks simply will not lend to most early stage businesses, so these businesses need to turn to investors to get going, fund their growth and fund their expansion. The EIS scheme is a significant job creator, with 4 new jobs created for each £1m invested according to the EISA. When the 10-year scheme limit was enacted, much consternation was expressed. We are now over half way through that window and need to have assurances that the scheme will continue.

4. Reducing the admin burden

We live in a digital age in which all PAYE information is instantly known to HMRC; all VAT information is reported instantly to HMRC; and all accounts and tax returns will soon be instantly reported to HMRC.

By comparison, EIS is reported through a combination of a manually-completed document that prompts HMRC to issue a PDF certificate, authorising the company to prepare and issue forms to the investors who then can manually complete it and submit in the tax returns or directly to HMRC. This is archaic. It should be possible for the post-EIS investment form to be digitally uploaded and, once accepted by HMRC, each investor’s tax recorded updated to record the investment.

Final thoughts

In addition to the above, EISA also recommends HM Treasury investigates how money held in pension funds can be used to fund EIS and SEIS qualifying companies and how to raise the profiles of EIS and SEIS investments.

The EISA letter is first class. It is a well researched, well presented and well thought-through request for support. Support that the government can provide without massive cost to the exchequer, and that will enable the economy to grow.

C+T nominated for Best EIS/ SEIS Tax Adviser award

We are delighted to announce that Chiene + Tait has been nominated for the Best EIS/SEIS Tax Adviser award at the EISA Awards 2020, the annual celebration of the #EIS, #VCT and tax efficient investment industry and community.

This will be the fifth year the firm is nominated, having been ‘Highly Commended’ for the last four years, the only firm in Scotland to have ever achieved this Tickets for the Awards ceremony can be found here: https://bit.ly/2EXu4eg

EISA Awards Nomination 2020

EIS: The Current Landscape and Future Trends

The Enterprise Investment Scheme (EIS) has seen a lot of changes in recent years with the main focus of concentrating the scheme on high-growth companies, thereby re-positioning the market towards greater risk. The move from capital preservation to more organic high-growth companies has been driven by the new risk to capital condition. This has seen investment lean heavily towards the technology sector, whereas previously more investments were made in the infrastructure sector, which is traditionally more asset-backed, and the media and entertainment industry, using special purpose vehicles.

Although these changes may be realigning EIS with that of its intended purpose (focused on high-growth companies), their overall impact and therefore the number of businesses supported may be difficult to realise with the ever-looming issue of Brexit. Furthermore, it is expected that the changes will result in a drop in the number EIS investments made, however, we will need to wait until Spring 2020 when HMRC publishes its annual statistics for these effects to be quantified.

In summary, the volume of EIS investments completed has been steadily increasing for several years, and the figures published for the 2017/18 tax year show no divergence from this trend. As mentioned previously, these results are expected to drop significantly in response to the introduction of the risk to capital condition introduced last year.

EIS Investments HMRC 2019
Source: Alternative Investment Report 19/20: Enterprise Investment Scheme – Industry Report (Intelligent Partnership)

 

Although EIS is a hugely lucrative and popular scheme, there still seems to be an abnormally low level of utilisation in Scotland. Of the 3,920 EIS investments made in 2017/18, only 185 (5%) of them were made in Scottish companies, and a large number of the investments were in London based companies (1,860).[1]

The knowledge-intensive companies rules have seen several changes since their introduction in the 2015 Finance Act, the most recent of which sees the annual investment limits doubled to £2m and

10m for individuals and companies, respectively. HMRC have also been granted powers to approve knowledge-intensive funds, which should increase their use in the industry.[1]

HMRC’s Advance Assurance application process has also seen significant changes recently with the rejection of speculative applications and the introduction of a compulsory checklist. The change in HMRC’s position towards speculative applications (i.e. now refusing to consider them) has seen a reduction in the number of applications submitted, this is thought to have been done to ease the load on HMRC. However, it has caused some frustration in the industry, as investment opportunities were previously assessed by investors after Advance Assurance had been acquired. The figures also show that the percentage of submitted applications being accepted has dropped significantly, this may be in response to the new risk to capital condition that gives HMRC inspectors added discretion when it comes to accepting or rejecting applications.

ASA requests
Source: Alternative Investment Report 19/20: Enterprise Investment Scheme – Industry Report (Intelligent Partnership)

It seems as though the Government is attempting to direct EIS investment back towards high-growth, entrepreneurial companies and that can only be good for the economy. Although the investors in the market may be frustrated by these changes, it is unlikely that the level of investment made using EIS will change substantially due to how rewarding the scheme is in terms of tax breaks. With Brexit looming on the horizon, EIS may be subject to further changes as the EU state aid rules will no longer be enforced.[1] This may free the UK Governments hand to determine how they wish the tax relief to be structured.

As the EIS legislation becomes increasingly complex, and HMRC flex their muscles regarding the risk to capital condition, the need for experienced EIS advisors continues to grow. If you have a query about EIS investment or generally investing in a company, please contact Ryan today at ryan.lewis@chiene.co.uk.

Quick investment required? Could ASA save the day?

If you are looking to plug a funding gap quickly and easily, whilst ensuring EIS tax relief for your investors, there are few options available. A funding round from new or existing investors can be a lengthy process, requiring due diligence, valuation agreement and long-form legal documents.

A convertible loan note sometimes causes problems under the ‘Receipt of Value’ rules or the ‘Independent Investor’ requirement, and often remains on the company’s balance sheet until the company stops looking for EIS investors and all EIS investments have been held for three years. Potentially a long wait!

Advance Subscription Agreements (ASA) are a useful option. A valuation doesn’t need to be immediately agreed, the legal process is quite straightforward, and the company doesn’t need to worry about finding the funds to repay a loan or interest. Best of all, if implemented correctly, investors can get EIS relief on the investment! It seems like a win-win situation.

Advance assurance is strongly recommended by HMRC to companies looking for EIS investment. However, with no official parameters or guidance there has always been a large element of the unknown.

Until now…

HMRC released guidance on 30 December 2019 which sets out the key points to consider when using or drafting an ASA for EIS investors. A couple of important points are as follows:

  • Simplicity will help the qualifying status!
  • It cannot permit refunds under any circumstances.
  • No variation, cancellation or assignment.
  • No interest payable.
  • A longstop date (the date the shares must be issued if no funding round occurs) no more than 6 months later.
  • Advance assurance must be sought BEFORE an ASA is entered into if it is being sought.

An interesting point to note is that the EIS compliance forms will need to be completed once the shares have been issued. So, it must be shown that all the EIS requirements are met at the date of that issue. One thing to highlight is the ‘Use of funds’ requirement; can the company show that the funds from the ASA are being used to develop and grow the trade, at the date of conversion into shares? The company needs to show why it needs those funds at the date of conversion, and the purpose cannot simply be to meet existing day-to-day expenditure.

The HMRC guidance is helpful but by no means gives companies, advisors or investors a guarantee that an investment under an ASA will qualify for relief. Advance assurance is always the feather in any company’s cap when seeking any investment under EIS, and when using an ASA it is even more important. HMRC’s new guidance can be found here.

 

If you have a query about EIS or using an Advance Subscription Agreement, contact Kirsty Paton today at entrepreneur@chiene.co.uk.

How (a background in) sport has helped me settle in at C+T

Playing sports has always played a huge role in my life, filling the majority of free time I have. I feel the experiences I have encountered through playing sport have allowed me to begin developing the skills necessary to be successful in my professional career. However, in order to develop my skills further, I needed real exposure to a professional environment which is where C+T comes in.

Going back to this time last year, summer 2018, I was about to take on one of the most exciting challenges, one that on paper seems very different to the challenge here at C+T, but surprisingly had many similarities.

Setting off on my own on the 18,000km+ journey to Christchurch, New Zealand to play rugby with one of the country’s most prestigious teams is something I had previously only dreamed of. The complete unknown loomed from my first step on NZ soil. Everything was new to me; the people, the culture and the environment in general were a huge change – the term ‘thrown into the deep end’ springs to mind!

You might be wondering what this has to do with an Entrepreneurial Tax Internship in Edinburgh? The feelings I faced on day 1 here at C+T were similar, albeit I wasn’t throwing myself around the office (most of the time). Entering a new, professional environment comes with the same feelings of uncertainty, which I have come to realise must be cherished and taken full advantage of. The opportunity to do something new and different allows you to develop and grow as an individual, both in the office, on the field and in life generally.

After somewhat settling into life here as an intern I have been exposed to a vast variety of taxes, tax reliefs and tax procedures from CGT to EMIs to completing corporation tax provisions. I cannot speak highly enough of the patience and understanding I have had from everyone thus far; I assume that an intern asking questions every five minutes can be a bit irritating (to say the least!), but if you don’t ask, how do you ever learn?

I have thoroughly enjoyed being exposed to the R&D team at C+T, learning about legislation regarding tax relief has allowed me to understand the substantial impact that correct R&D advice can have on a business. Listening in on calls and seeing first-hand the interactions between clients showcased the friendly, but professional manner that C+T hold themselves to. Working with the R&D department, I got the chance to learn and understand the new and unique technological advancements each client makes, something I found to be a fascinating!

One final thing that stands out for me about C+T are the people. They say the people make the firm and I believe that to be true here at C+T. Like the Kiwis, I received a warm welcome, they really made me feel like part of the team from day 1, showing me that C+T put an emphasis on developing relationships both internally and externally.

Overall, I am looking forward to furthering my knowledge and developing my skills in my final two weeks at C+T and I am excited for any future challenges that may arise both in the office and the field.

New blog: my time working in the Entrepreneurial Tax Team

Mid-way through my third year at university, summer internships seemed to be on everyone’s mind. Most people I knew were talking about the roles that they had applied for and how important internships were for putting you in a good starting position post-university. Doing an internship seemed like a great idea, it would provide me with an interesting way to fill my 3-month summer break, learn more about the working world and develop new skills. Having enjoyed the brief two weeks of work experience I had done with Chiene + Tait the previous summer, an internship with the entrepreneurial tax team seemed like the ideal opportunity.  I applied and was thrilled when I was offered an interview and even more thrilled when I was offered a six-week position with the firm.

Going from university to working at Chiene + Tait took some adjustment. I’m currently studying Economics and Modern History and I thought when I first joined the firm that studying these subjects would be vastly different to working in an accountancy firm. At university I only have around six contact hours a week  (I’m sure the English and international students must wonder what they’re paying for a lot of the time) and, although the lack of teaching time does mean a significant amount of independent study and long days spent in the library, it is often quite an unstructured working environment. Joining the firm this summer has given me an insight into what my working life could be like. I have also found that although some of the knowledge I have gained from university may not always be useful (or who knows maybe one day that modern history essay on the cultural impact of the miniskirt will come in handy), the skills I have gained often are.

‘So, what actually is entrepreneurial tax?’ A question I have been asked many times by my friends and family since starting my internship at Chiene + Tait this summer, and one that I struggled to fully answer at first. Over the past three weeks I have quickly learned what a job in entrepreneurial tax entails (although from writing this blog I’m beginning to realise that I may never learn how to spell entrepreneurial), and I have seen the great work that Chiene + Tait does for growing businesses. Throughout my time here I’ve been assigned interesting and engaging work to do with the various schemes available to companies and investors. From Enterprise Management Incentives (EMI) to Enterprise Investment Schemes (EIS) and Research & Development Tax Credits the variety of work I have been assigned has been challenging but also enjoyable. It has shown me just how many fascinating companies the firm deals with.  I’ve even attempted some Corporate Tax which I think I might be finally wrapping my head around. In just three weeks my knowledge of Entrepreneurial Tax and other types of tax has grown substantially, and I can now provide a more detailed answer when people ask me what entrepreneurial tax is.

The work and type of clients have been very interesting but above all, being made to feel part of such a friendly team has made the whole experience very enjoyable.