Enterprise Investment Scheme Relief – Get it Right!

The relief in outline
EIS relief is available where an individual subscribes in cash for ordinary shares (with no preferential rights) in a qualifying unquoted company. Furthermore, shares only attract tax relief if they are fully paid up. The relief consists of four elements:

• The investor can claim to reduce his income tax liability by an amount equal to 30% (for subscriptions post 5 April 2011) of his share subscription.The maximum subscription, which attracts tax relief, is £500,000 but this limit increases to £1m with effect from 5 April 2012.
• The investor can defer gains arising from the disposal of an asset or where a previously deferred gain becomes taxable. The event giving rise to the gain must have occurred within the 36 months before the EIS investment or within the following12 months. There is no upper limit on the subscription or the gains that can be deferred.
• Any gain realised on a disposal of EIS shares is tax free provided the shares have been held for at least three years and the EIS income tax relief has been given and not withdrawn.

Clearances and claims for relief
Before the EIS shares are issued HMRC are happy to consider information provided by the company relating to the proposed issue and give an opinion as to whether the company and its trade should qualify under the EIS.

The EIS income tax relief and deferral relief can only be claimed after the shares have been issued and the company has carried on a qualifying business activity for four months. The Inspector will authorise the issue of tax relief certificates (EIS 3s) when he is satisfied that the company has met the EIS conditions and intends to continue to do so.

This all sounds very straight-forward but evidence suggests that the Inspector looks for mistakes in both the issuing of shares and the claiming of the relief; non-compliance in the most innocent of areas can result in denial of relief.

Practical Issues
The EIS was introduced in January 1994 but its origins go back to the 1981 Business Start Up Scheme, and the 1983 Business Expansion Scheme (BES). Back in 1981 the Business Start Up Scheme was introduced to attract cheap funds for business when lending from banks was much reduced. Lending-wise, not much has changed in 2011 and it is hard to justify the (sometimes) unforgiving stance made by many an Inspector in granting EIS relief.

Value received
The ‘value received’ rules are a particular problem and HMRC has denied relief in the past where money invested for the share issue and the share register are not written up at the same time. This happened in the infamous Blackburn case (Blackburn and anor v Revenue & Customs Comrs) in which HMRC argued the delay between payment and registration was evidence of the existence of a debt owed back to Mr Blackburn, this debt being repaid when the share issue took place. The ‘value received’ rules had been breached according to the Inspector and relief was lost.

Although legislation has changed in recent years best practice is to ensure that an agreement is in place between the investor and the company to evidence the money invested is by way of share subscription in relation to an issue of shares and for no other reason.

Shares must be issued
The joint cases of National Westminster Bank plc v IRC and Barclays Bank plc v IRC [1993] STC 639, 67 TC are authority for showing that shares must be issued for relief to be obtained. To prevent enquiry in this area the share register should be written up on the same day the money is received.

The EIS legislation is not at all straight-forward and close attention is required from a compliance perspective. As HMRC can be unforgiving it is wise to take advice at every stage of the compliance process.