EIS and SEIS relief are being considered by a large number of companies at the moment as a way of raising funds but at the same time enabling investors to obtain attractive income tax and capital gains tax reliefs.
A number of cases have been heard before the First tier and Upper Tribunals that demonstrate how easy it is to fall foul of the complex provisions granting these reliefs. Moreover, there have been a number of changes to the legislation in recent years, and more changes have been announced that will have a significant impact on the operation of the relief.
Risk to capital condition
In particular, the Finance Act 2018, which is likely to receive Royal Assent at the end of March contains provisions that are intended to ensure that there is a real risk to capital for investors in EIS and SEIS shares. The purpose of these provisions is to prevent investment in companies whose activities are geared towards the preservation of capital rather than long term growth.
A new s 157A will be inserted into ITA 2007 which sets out the “risk-to-capital condition”, which is met if, having regard to all the circumstances existing at the time of the issue of the shares, it would be reasonable to conclude that (a) the issuing company has objectives to grow and develop its trade in the long-term, and (b) there is a significant risk that there will be a loss of capital of an amount greater than the net investment return. Similar provisions will be introduced for SEIS companies.
The real aim of these new provisions is to prevent EIS or SEIS companies from raising EIS funds where there is a pre-agreed supply and a pre-agreed sale for the goods produced by the company, so that the profit can be measured with reasonable certainty in advance and the risk to capital is remote.
However, in considering the risk to capital condition, it seems clear that once the provisions come into force (a date has to be set by the Treasury after Royal Assent), any company seeking to raise EIS or SEIS funds will need to ensure they have a clear intention to grow the business. This could prejudice a range of companies that could offer EIS/SEIS shares to their investors under current provisions.
For example, an EIS company could be formed to operate a single pub under current provisions. However, once the risk to capital condition comes into force, it would be difficult to demonstrate that the company’s objective is to grow the business. Instead, the company would have to be formed with the aim of developing a chain of pubs. Companies with a single ring-fenced objective may no longer be able to raise EIS/SEIS funds.
Changes to advance assurance
It is possible to seek advance assurance from HMRC that a company is a qualifying company for the purposes of EIS/SEIS purposes. HMRC issued a consultation document in 2016 looking at the future of the advance assurance facility in view of two main concerns. The first of these was a resourcing issue, but the second was a concern that only a minority of applications actually led to shares being issued and that the service was being used speculatively to test how far particular aspects of the EIS/SEIS provisions can be pushed.
As a result, with effect from 2 January 2018 HMRC will not provide an advance assurance on speculative applications. They will provide an opinion only where the application names the persons who are expected to make their investment. This could cause some problems in promoting EIS investment as it is common for an information memorandum (IM) to include confirmation that advance assurance has been obtained, as the IM is used as a tool for identifying potential investors.
However, even where an IM is not required, a company may not be able to make an application for advance assurance until a later stage in the process than they would have done previously. Moreover, although it has always been a requirement that a business plan or similar document is provided to HMRC as part of the advance assurance application, it is likely that more detailed information will be required in order to satisfy HMRC that the application is not speculative.
In order to be able to raise funds under EIS/SEIS companies will need to focus on the content of their business plan to ensure that there is a clear objective in growing the business. This is likely to require projections for increases in turnover, staff numbers, customers, for example. Companies with a static workforce, turnover, customer base, are likely to struggle to satisfy the risk-to-capital provisions.
Where advance assurance is required, investors will need to be lined up in advance of making the application, so that HMRC are satisfied that the application is not speculative.