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Tax Bite - Top 10 SEIS/EIS Pitfalls

SEIS/EIS remains a very powerful tool for attracting investors and de-risking their investment to an extent. SEIS offers a 50% relief and EIS offers a 30% relief - this means that an amount equal to 50%/30% (as applicable) of the amount invested can be set against the investor’s income tax bill. If the investment is not successful and losses are made, the losses (less any relief claimed) can be set against income. Added to the CGT free exit (if various conditions are met) these are therefore very generous reliefs and help mitigate the downside risk of what are risky investments.

However the rules are complex and the reliefs can be inadvertently lost. Here is our top 10 of the most common SEIS/EIS pitfalls we see (which will hopefully help you to avoid them):-

1. SEIS and EIS Shares issued on same day SEIS shares will not qualify if EIS shares are issued on the same day. It is therefore necessary to structure an investment so that the SEIS shares are issued for cash on day one (and the register of members written up) and the EIS shares are then issued at least one day later. If they are all issued on the same day it should be possible to claim EIS in respect of all of the shares but HMRC will not accept an SEIS claim.

2. Mistakes on EIS1/SEIS1 forms On an investment where there are SIS and EIS monies, a company can decide how it wishes to allocate SEIS and EIS as amongst its investors (subject to the point above and taking into account the SEIS limit of £150k per company). But once this allocation has been included on the SEIS1 and EIS1 forms, it is set in stone and cannot be changed. Likewise if an EIS1 form is submitted by accident in respect of what were intended to be SEIS shares, this cannot be undone and HMRC will not accept a claim for SEIS instead (although the EIS claim should stand). This is not a problem if done the other way around i.e. if an SEIS1 form is submitted in error, an EIS1 form can later be submitted instead.

3. 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, this will result in a clawback of EIS relief for the EIS shareholders if it takes place within the 12 months before or the 3 years after an EIS share issue. This is a particularly nasty little rule which catches many companies out.

4. Joint Ventures Joint ventures are not prohibited under SEIS/EIS but they may nonetheless result in the company failing to qualify as there are several legislative SEIS and EIS requirements which may not be met where there is a joint venture arrangement. These include the trading requirement, the requirement that no other person must carry on the same activity as the SEIS/EIS company and the requirement that any company controlled by the company (and its connected persons which may in certain circumstnaces include the joint venture partner) must be a 51% subsidiary.

5. EIS 7 year rule It is a requirement of EIS that the EIS investment takes place within 7 years of the first commercial sale. This test is very wide and needs to be checked carefully. 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). There is a helpful get out for follow-on investments where EIS shares have already been issued within the original 7 year timeframe as long as the funds are used for the same business. There are also the new product market/geographic market exemptions but these are tricky to come within and must be looked at very carefully if seeking to rely on them.

6. The trading requirement 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. This is a different and much harsher test than the “substantial” (broadly 20%, but each case would turn on its facts) threshold which applies to SEIS/EIS companies with subsidiaries (but still one company in the group must exist wholly for trading). This means any external letting of property or non-subsidiary holding of shares, for example, will be a problem in a single company whereas it would typically only be a problem if it amounted to more than 20% of the group’s activities where there is a group of companies.

7. Licensing of IP The SEIS/EIS company (or group as applicable) 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 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 (and which companies form the group for this purpose needs to be checked carefully). It will always be necessary to dig into the detail of the IP’s history. Buying in subsidiaries with IP or even internal group reorganisations can result in the IP not being treated as having been developed internally.

8. Controlled by another company 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. This can be an issue for example where a controlling individual also holds a small shareholding through a company – their interests will be aggregated and the corporate shareholder will be treated as controlling the SEIS/EIS company for this purpose. 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. This means it is necessary to take into account all options, warrants, convertible loans and other potential arrangements in order to work out if there is a scenario where a company might end up controlling the SEIS/EIS company.

9. 30% test and nominal value 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 limited circumstances). When measuring the 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.

10. Loans If loans are repaid to an SEIS/EIS investor 12 months before an EIS/SEIS share issue or within three years afterwards 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.