11 NOVEL Ways to DESTROY SEIS & EIS Tax Relief

Maintaining (S)EIS eligibility for your investor(s) should be towards the top of your priority list. In this article I explore the various ways in which you could inadvertently cause an issue with these schemes and, more importantly, how you can avoid this pitfall.

There are plenty of ways to make your company ineligible for (S)EIS investment:

• Time limits
• Substantially being involved with non-qualifying trades
• Asset tests
• Permanent establishment and ownership rules
• Shares being not ‘paid wholly in cash’ and much more.

Let’s not forget there are quite a few ways that investors can make themselves ineligible for the schemes.

For example, by being a director in a business before trying to invest under (S)EIS or making an investment outside of the scheme and then trying to make use of (S)EIS?at a later date .

But, let’s say that you’ve got (S)EIS advance assurance in place to ensure investors have comfort that their investment will qualify for the lucrative tax break.

You’ve taken the cash, issued share certificates, sent (S)EIS1 forms to HMRC and issued (S)EIS3 forms to investors.

The paperwork is done, your (S)EIS worries are over, and you can forget about those schemes now?

The (HMRC) Empire Strikes Back

Not quite...The (S)EIS schemes remain very brittle – you need to ensure that you don’t do anything to inadvertently destroy the tax relief for your investors.

This article details many, but not all, scenarios under which this can occur.

If you do breach the rules, then investors stand to lose all (S)EIS benefits, specifically:

1. They will need to repay any upfront relief (50% for SEIS, 30% for EIS) that they’ve already received;
2. They lose the inheritance tax relief that would normally be afforded once the investor owns the shares for two years;
3. They lose the loss protection afforded by these schemes; and
4. If you do successfully exit and they make a profit on the shares, then they may have to pay capital gains tax on the?gain in value .

That is a very disappointing outcome for your investor(s) and there are a few good reasons why you should do all you can to preserve relief for your investors:

1. You will annoy your investors – which means they are very much less likely to put more money in during later rounds; and
2. You have (probably) given an undertaking in your shareholders agreement to not destroy tax reliefs. If you do so, you are potentially facing a breach of contract claim against the company.

Nuances of SEIS vs EIS

Just before we dive into the detail, it is interesting to note that the SEIS and EIS rules are 90% identical – but there are some nuances to both schemes that are very much worth watching out for.

We identify some of those below – there are plenty more lurking around!

As an example, under SEIS there is a rule that “The company has never been controlled by another company“, whereas under EIS there is a similar but more relaxed rule

‘At the date of share issue, the company will not be controlled by another company’.

Anyway, on to the SEIS / EIS-destroying situations to be aware of:

1. Investment outside of the two year time limit

Many think that the two-year time limit for SEIS starts when you receive advance assurance, when you incorporate or something else.

Using SEIS within the time limit is essential if your investors are to benefit from the scheme.

According to the HMRC manual: A ‘new qualifying trade’ is defined as being one which has not been carried on by either the company or by any other person for longer than two years at the date of issue of the shares; and where neither the company nor any qualifying subsidiary had carried on any other trade before the company in question began to carry on the new trade.

When does the two-year countdown start? Unfortunately, the legislation and written HMRC guidance is opaque.

However, HMRC inspectors use the following analogy: you are preparing to open a new shop.

Whilst the shop is being fitted out, the stock is being put on shelves for the first time, the sign on the front door would indicate ‘Closed’.

As soon as you flip the sign to open, you have then commenced trading, even if nobody buys from you (or even enters the shop) for a couple of months.

2. Raising via EIS or VCT before SEIS

This item is very straightforward.

At the point you issue shares under the SEIS scheme you will be asked to confirm that no shares which qualified for EIS have previously been issued or that the company has not received any previous investment from a Venture Capital Trust.

You therefore must ensure that all SEIS shares are allocated before you go on to issue shares under EIS or VCT.

3. Raising SEIS and EIS on the same day

This potential gotcha is easy to trip over – if you are doing a ‘dual round’ – i.e. raising ￡150k via SEIS and ￡150k via EIS.

For example, and even just one EIS gets their shares on the same day as the SEIS shares are issued then this could destroy eligibility under one of the schemes https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm8030

You may wish to use a process similar to the following to avoid this item:

1. Before you close your funding round for signing communicate specifically to each and every investor that they shouldn’t transfer any investment funds until you communicate with them again.
2. Once all documents are signed, communicate to all SEIS investors that they should transfer the SEIS funds only at this point. At this stage I would specifically advise investors individually regarding how much they should be transferring under SEIS. Note: If you have investors subscribing for both SEIS and EIS investment during this funding round (e.g. someone is investing ￡10k which has been split as ￡7k SEIS and ￡3k EIS) then this investor should be instructed to only transfer the ￡7k SEIS portion at this stage.
3. Check your bank account for received funds and chase investors. When you do receive a payment from a specific SEIS investor, you should mark the investment as received on the FounderCatalyst platform. This step ensures that the share certificates will be issued on the correct date.
4. Only once you have confirmed receipt of all SEIS investment and issued all SEIS share certificates should you pass this point on the process.
5. Wait a day – you must not issue SEIS and EIS shares on the same day.
6. Now instruct EIS investors to transfer investment funds.
7. Again, mark the funds as received on the FounderCatalyst as you get visibility of the funds arrive in the company bank account.

Clear and consistent communication with your investors is key in this scenario, to prevent the loss of either SEIS or EIS eligibility for all investors.

4. Repaying a loan with EIS

Another oddity between the two schemes – you can pay a director’s loan with SEIS funds, but not EIS funds.

True story!

Usually, your investors will not want you to do this anyway.

They may well have investor consents to limit your ability to do so, so this item may not be a huge issue in practice.

5. Exiting too soon

To continue to benefit from the tax breaks with both SEIS and EIS you need to hold the shares for at least three years.

Some businesses get acquired sooner than anyone envisages. As an example, one of my investments had an amazing offer for acquisition after two years and nine months.

If they were acquired before the three-year anniversary then I’d have felt some tax pain – I’d have had to refund any tax relief already received and then pay CGT on the increase in value of my shares.

Not ideal!

Thankfully, the negotiation dragged on a little and the exit actually occurred just after the three-year anniversary, so all of the EIS reliefs remained intact.

6. Not spending the investment money within the relevant period

Again, this is slightly different between SEIS and EIS:

For SEIS, you must spend the money within a three-year period.

For EIS, this period is a?little different :

1. 2 years from the issue of the shares;
2. if the activity consists of preparing to carry on a trade, 2 years from the issue of the shares or, if later, 2 years from when the company begins to carry on the trade.

Want to know the other 5 Ways?

Read the full article .

About Sam Simpson and Catalyst Founder

Sam is Co-Founder & COO at?FounderCatalyst, an exciting and disruptive play into the UK legal tech sector, underpinned by a superb technology platform.?

Trusted by founders, investors, advisors and funding groups, FounderCatalyst quickly and professionally creates all of the legal paperwork and helps manage investor engagement.

"FounderCatalyst's services and support have been instrumental in guiding us through the intricacies of SEIS/EIS advance assurance and our legal paperwork, including clarifying the legal jargon.

This has significantly contributed to our early stage growth."

Taliesin Horton-Horsman, co-founder, Touch Immersion Ltd

Sam's specialist areas include SEIS and EIS advance assurance, investor management & negotiation, and successfully closing funding rounds, so if you have any burning questions?book a quick chat.

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