The SEIS rules are designed to mirror the EIS rules (but there are differences between the two regimes), as it is anticipated that companies that have raised seed funding through SEIS will then go on and raise further investment under EIS.
Both schemes offer generous levels of income tax relief (broadly, SEIS investors can offset 50% of the value of their investment against their income tax bill, whilst EIS investors are entitled to offset 30%) and capital gains tax relief (SEIS and EIS investors pay no capital gains on the sale of their investments if certain conditions are met).
Reflecting the high(er) risk nature of SEIS and EIS investments, the schemes also mitigate the downside for investors. If a SEIS or EIS investment is not successful, an investor’s losses (less any relief claimed) can be set off against income tax.
These tax reliefs, and the others available under the schemes, are subject to financial limits and complex rules, which unless carefully navigated, can be inadvertently lost.
Here we have set out ten common SEIS and EIS pitfalls that could ruin your day:
- Be careful if SEIS and EIS Shares are issued on the same day: SEIS shares will not qualify if EIS shares are issued on the same day. This can be overcome by structuring an investment so SEIS shares are issued for cash on day one (and the register of members written up) and EIS shares are issued at least one day later.
- Avoid admin mistakes on EIS1/SEIS1 forms: On an investment where there are SEIS and EIS monies, a company can decide how to allocate SEIS and EIS amongst its investors. Once this allocation has been included on the SEIS1 and EIS1 forms, it is set in stone and cannot be changed. If an EIS1 form is submitted by accident in respect of what were intended to be SEIS shares, this cannot be undone. HMRC will not accept a claim for SEIS. However, this is not an issue if an SEIS1 form is submitted in error.
- Stay alert with buybacks/returns of capital: If non-EIS shares are bought back from non-EIS shareholders or there is some other repayment or return of share capital 12 months before or 3 years after an EIS share issue, this will result in a clawback of EIS relief for the EIS shareholders. This rule catches out many companies.
- Joint Ventures can cause problems: Joint ventures are not strictly prohibited under SEIS/EIS but there are several legislative SEIS and EIS requirements which may not be met where there is a joint venture arrangement. These include, for example, the requirement that no other person must carry on the same activity as the SEIS/EIS company.
- The EIS 7 year rule is important: It is a requirement for the EIS investment to take place within 7 years of the first commercial sale. This test is very wide and needs to be carefully considered. It is necessary to look at the first commercial sale of various persons including the company, any subsidiaries, any person who previously carried on the trade, subsidiaries which have been sold and subsidiaries acquired after the EIS share issue (but only where EIS monies will be used in that subsidiary). Although there are new product market/geographic market exemptions, these are tricky to come within and must also be carefully considered, if relevant.
- The trading requirement is for real: SEIS/EIS companies must meet the trading requirement. For companies with no subsidiaries this means that if they carry on any investment activities the company will not qualify unless the investment activities are incidental.
- Licensing of IP can be tricky: The SEIS/EIS company (or group) must not carry on to a substantial extent (broadly 20%, but each case would turn on its facts) any excluded activities. These are the same list as for Enterprise Management Incentives (“EMI”) companies and includes licensing of IP unless the company created the greater part of the value of the IP internally i.e. by the company or the group (which companies form part of the group for this purpose needs to be carefully considered).
- Being controlled by another company is a problem: The SEIS/EIS company must not be under the control of another company. This is a very wide test (very similar to the EMI test) and requires you to aggregate the interests of any persons connected with the potentially controlling company. It even applies where there are “arrangements” by virtue of which the company could (as opposed to “will”) come under the control of another company. As a result, it is necessary to consider all options, warrants, convertible loans and other potential arrangements in order to work out if there are any circumstances under which a company might end up controlling the SEIS/EIS company.
- Make sure the 30% test and nominal value test can always be met: It is a requirement that no SEIS/EIS investor (together with their associates) holds more than 30% of the ordinary share capital or votes (and even loan capital in certain circumstances). When measuring ordinary share capital you look at the nominal value of the shares. Therefore if you have different nominal values (e.g. some £0.01 shares and some £1 shares) you could inadvertently fall foul of this test.
- Be careful with loans: If loans are repaid to an SEIS/EIS investor 12 months before or three years after an EIS/SEIS share issue there will likely be a clawback of SEIS/EIS for that investor (or, if before the subscription, may prevent it from ever qualifying for SEIS/EIS). Converting the loan into equity does not solve this problem as that is potentially counted as a repayment so the same issue arises. Usually the loans have to be left in place (with no repayment or conversion) until the expiry of the 3 year period if the SEIS/EIS relief is not to be disturbed.
SEIS/EIS can be very effective at de-risking investors’ investment but it is important to obtain advice to ensure these and other issues are avoided. If you would like to discuss these or any other matters, please contact Mark Tasker ([email protected]), Stephen Callender ([email protected]) or anyone in our Corporate team.
This information is necessarily of a general nature and doesn’t constitute legal advice. This is not a substitute for formal legal advice, given in the context of full information under an engagement with Bates Wells.
All content on this page is correct as of June 23, 2020.