By Matthew Cushen
Equity investing in early stage start-up businesses is becoming an increasingly common component of a diversified portfolio. Part of the attraction of funding start-ups continues to be a highly attractive tax regime that encourages investment into seed enterprises with generous tax reliefs.
In their much maligned 2017 manifesto, the Tories described two schemes as world leading: “We will help innovators and start-ups, by encouraging early stage investment and considering further incentives under our world-leading Enterprise Investment Scheme and Seed Enterprise Investment Scheme.” Page 77, Conservative Party 2017 Manifesto.
The Enterprise Investment Scheme (EIS) was set up in 1994 and continued to be supported through Labour governments. It has since been made more attractive by the Conservative government, and has established itself as a part of tax legislation that neither of the main parties would be likely to compromise.
The Seed Enterprise Investment Scheme (SEIS), established in 2012, is an extension of EIS and offers even more generous reliefs. In the 2015/16 tax year, 2,225 companies raised £170 million through SEIS.
Both are going to be reviewed, and possibly strengthened, as part of the ‘Patient Capital Review’ announced by the Prime Minister in Autumn 2016 and mentioned in Philip Hammond’s Spring 2017 budget. The results of the review may form part of the Autumn 2017 budget.
But investors need not wait, there are already significant tax advantages for investing under the SEIS scheme.
A company is likely to qualify for the SEIS scheme if:
- They have been trading for less than 2 years
- They have less than £200,000 in gross assets and few than 25 full time employees (or part time equivalent) at the time of the share issue
- They are in a ‘qualifying trade’: most trades are qualifying, but some, such as some financial services and dealing in land & property development (including property intensive activities such as hotels or nursing homes) are excluded
Then the company can raise £150,000 in funding covered by SEIS reliefs so their equity investors benefit from a range of tax reliefs that significantly reduce their risks and increase their returns. Under SEIS, investors qualify to reduce their tax liability immediately for the current or previous tax year:
- 50% INCOME TAX RELIEF: half of the investment is reclaimed from income tax for the current, or in many cases preceding, tax year
- 50% CAPITAL GAINS TAX (CGT) REINVESTMENT RELIEF: if a gain has been realised in the same, or in many cases the preceding, tax year, an investor can reduce their CGT bill by half – usually worth another 10% of the investment figure, but sometimes more
- The investments are 100% INHERITANCE TAX RELIEF EXEMPT, provided that investments are held for two years.
Then there are further reliefs dependent on the performance of the investment:
- 100% CAPITAL GAINS TAX FREE: any gain on the investment is free from all capital gains tax after being held for 3 years
- LOSS RELIEF: in the event that a company fails, the net investment, total minus reliefs already claimed can be used to reduce income tax liability further
These tax reliefs are cumulative, for example, a higher rate tax payer, making a £50,000 investment could benefit thus:
Investment = £50,000
Income tax relief @ 50% = £25,000
CGT re-investment relief on £25,000 @ 20% = £5,000
Therefore the net investment is £20,000 and reliefs reclaimed are 60%.
Should the company fail, a further income tax relief on the net investment, in this example, for a higher rate tax payer @ 45% = £9,000
So the total reliefs = £39,000 or 78% of the original investment. (This can even be greater if the CGT re-investment relief is on a 28% CGT rate.)
Under UK taxation legislation, the maximum amount on which an investor can obtain SEIS tax reliefs in any tax year is currently limited to £100,000. Each spouse or civil partner has his or her own limit of £100,000 and they are not aggregated.
This limit applies for all SEIS investments made within a given tax year. This limit does not apply to capital gains tax re-investment or IHT relief. SEIS investors are permitted to carry back their investment to the previous tax year, so long as they have not used their individual limit in the previous tax year. Therefore, if investors have not used any of their £100,000 limit for the tax year ended 5 April 2016, then they could carry back up to £100,000 of their investment to that tax year. This could make a £200,000 investment the most tax efficient (or £400,000 across two spouses).
The value of the tax reliefs will depend on personal circumstances, which may change. References to tax are based upon current legislation and HMRC practice, which might be subject to change in the future. All investors are strongly encouraged to check their circumstances and potential reliefs with their tax adviser.
