Three interesting EIS elements to learn about

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

After being in corporation tax compliance for almost 5 years, I felt it was about time I gave my wings a little stretch…so here I am, a Senior Tax Associate in the entrepreneurial tax team at Chiene + Tait (C+T).

With the backdrop of a global pandemic, it was strange starting a new job. I returned my laptop from my previous job and that evening I received my new laptop from C+T.

During my first team meeting at C+T, there were many acronyms flying around and grappling with these was initially rather tricky; the pace here is fast and efficiency is important, so the many acronyms are a necessity.

I anticipated my new role would involve a steep learning curve and, I can now say after four weeks, it most definitely has lived up to that. At this meeting I was already being assigned client work which was really exciting. I was expecting my first week to mainly involve lots of health and safety training and suchlike but even though there was a lot of training on those areas, it was balanced by the client work I was involved in and the training I received on EMI and EIS.

In my first two weeks, I was already involved in EMI valuations, preparation for an EIS report and research for various ad-hoc advisory pieces of work. I had also attended R&D technical meetings with clients and have now started drafting one of those R&D reports.

After these couple of weeks, the acronyms started to fall out of my mouth and the jargon started to get a little easier to understand. However, it is important to always be on guard as new terminology still crops up. My depleting stash of sticky notes are proof of this.

Anyway, enough about me. Now to delve into some of the interesting insights I have learned from my EIS work so far – here are three which show how complicated the subject can be, and the benefits of learning about it.

The Single Company Test versus the Substantial Test

If a single company wants to enter into a joint venture with another party, it should first consider either setting up or acquiring a subsidiary company (i.e. hold at least 51% of the shares in another company) before it does so.

The reason this is important for EIS is because it determines whether the company will be required to meet either the single company test or the substantial test. The substantial test applies when the company is part of a group and it is less difficult to meet than the single company test.

One of the requirements of EIS is that a company/group must either carry out a trading activity or exist wholly for the purposes to carry out a trading activity. Under the single company test, the legislation only permits an insignificant amount of the company’s activities to involve non-qualifying activities. The substantial test is that the group’s activities should consist of no more than 20% of non-qualifying activities. Therefore, by comparison, the substantial test has more flexibility.

The holding of investments is an example of a non-qualifying activity, and an example of an investment would be holding less than 51% shares in a company (for example, a joint venture). It is more difficult to prove, under the single company test, that holding such an investment is insignificant to the company’s overall activities than it is to prove that it is less than 20% of the group’s overall activities. As such, a company should therefore consider being part of a group (for example, by setting up its own dormant subsidiary) before it decides to enter into a joint venture, as it will be easier for it to preserve its EIS qualifying status.

If the single company test or substantial test is breached, the company would lose its EIS qualifying status.

The Control Condition

Continuing on from the above scenario involving an EIS company with a joint venture, it is also important that the ‘Control’ test is considered here. The ‘Control’ test requires that EIS companies can only have qualifying subsidiaries. This means that the EIS company can only control companies where it holds at least 51% of the shares.

Joint ventures tend to not be qualifying subsidiaries for the purposes of EIS, as the company will not usually hold more than 50% of the shares in that company. Therefore, it is important that the EIS company (in its own right or with a connected person) does not have control over the joint venture, and care should therefore be taken when drawing up joint venture/ shareholder agreements to ensure that this is so. If it does have control, the joint venture would be a subsidiary but not a qualifying subsidiary for the purposes of EIS.

If this requirement is breached, the company would lose its EIS qualifying status.

What to watch out for when spending money raised through EIS

A company is required to use the money raised from EIS wholly for the purposes of the qualifying business activity. The qualifying business activity must be carried out either by the company issuing the EIS shares or by a 90% qualifying subsidiary. The money raised should be employed within 2 years of the share issue (or, if it is later, 2 years from when the company begins its trade).

The legislation states that employing anything more than an insignificant amount of the money raised through EIS on a purpose which is not for a qualifying business activity will result in that round of investment being disqualified from EIS. For example, spending EIS money on a <90% qualifying subsidiary. A failure to meet the requirement does not itself result in the company losing its EIS status. The legislation allows for an insignificant amount of money raised to be employed for other purposes but does not specify what is meant by ‘not significant’.

If an investment round is disqualified from EIS, this can have a devastating effect for the investors in that round. The investors would lose their EIS relief for that disqualified investment round; and because of the ‘independent investor’ requirement under EIS, the investor would no longer be able to participate in future EIS rounds. This is because the investor would now hold shares which do not qualify for S(EIS) relief. It is therefore critical that a company takes care when spending money raised from EIS.

 

I hope you enjoyed reading about a few of the interesting insights I have picked up in EIS so far, and that it’s a useful guide to the kind of things you learn when you delve deeper into the subject.

If you have any queries on EIS, contact our team and we’ll be happy to help.