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In the current economic climate, offering a tax efficient option may make the difference between securing a potential investment and not. Sarah Brock, Corporation Tax Manager at Ward Williams, considers some of the opportunities available to encourage investment.

Business Structure

Before considering the potential tax incentives available to investors, it is worth taking the time to consider the structure of the business. The main tax incentives available to investors are available only to companies, (although Entrepreneurs’ Relief – see below – is open to unincorporated businesses as well), so if the business is not already incorporated, this may be worth considering. 

Enterprise Investment Scheme

The Enterprise Investment Scheme (EIS) is designed to help smaller high-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.  Subject to specific conditions being met, individuals are able to obtain income tax and capital gains tax reliefs on investments in newly issued shares in unquoted companies. The main reliefs are:

• Income tax relief at 30% of the cost of the shares up to a maximum of £500,000 in one tax year.
• Shares qualifying for income tax relief are free from Capital Gains Tax on disposal.
• Capital gains tax deferral relief. Where the proceeds of any gain are invested in qualifying EIS shares within certain time limits the payment of tax is deferred until the EIS shares are disposed of.

The main conditions for the investor are:

• Maximum investment of £1,000,000 per investor in any one tax year.
• Shares must be held for a minimum period of 3 years from the date of issue or from the date that the company started trading, if later.
• The investor must not be connected with the company.

and the company must:

• Be unquoted (although may be AIM listed).
• Not be controlled by another company.
• Have gross assets of less than £15m before any EIS share issue and £16m immediately after.
• Have fewer than 250 (full-time equivalent) employees.
• Carry on a qualifying trade or be the parent company of a company carrying on a qualifying trade.

Companies can raise up to £5m in any 12 month period under EIS.  It is important that investors are aware of the rules that the company has to observe, not just at the time of the investment, but for at least 3 years after. If it fails to meet those rules, tax relief will not be given, or, if it has already been given, will be withdrawn.

Seed EIS

The government is keen to encourage investment in small, start-up companies and, from 5 April 2012, introduced the Seed EIS.

The Seed EIS offers more generous reliefs to individuals investing in smaller, potentially risky, early stage companies who may otherwise experience barriers to raising external finance. In addition to a 50% income tax reduction, for the 2012/13 tax year only and for investments of up to £100,000, there is also an exemption from Capital Gains Tax for gains realised on any asset, on a £ for £ basis ,where the gains are invested in the Seed EIS.

The main conditions for Seed EIS companies are:

• Fewer than 25 (full-time equivalent) employees.
• Gross assets of up to £200,000 before qualifying shares issued.
• The company’s trade must not be more than 2 years old.
• Total amount raised under the Seed EIS is limited to £150,000.

Venture Capital Trusts

Venture Capital Trusts (VCTs) offer investors the chance to invest indirectly in a range of small, higher risk trading companies whose shares and securities are not listed on a recognised stock exchange.  VCTs are run by fund managers who are usually members of larger investment groups. Investors can subscribe for, or buy shares in, a VCT, which invests in trading companies, providing them with the funds to help them develop and grow. The main reliefs available to investors in VCTs, subject to an annual investment limit of £200,000, are:

• Exemption from income tax on dividends from ordinary shares in VCTs.
• Income tax relief at a rate of 30% of the amount subscribed.
• Relief from Capital Gains Tax on disposal of qualifying VCT shares.

The limits for qualifying companies are the same as the EIS limits.  Investors are required to hold their shares for at least 5 years. VCTs must be approved by HMRC and approval is given subject to a number of conditions being met.

Entrepreneurs’ Relief

The availability of Entrepreneurs’ Relief (ER) can make a potential investment much more attractive as a significant amount of tax can be saved when the investor chooses to exit.

ER allows individuals and some trustees to benefit from a lower 10% rate of capital gains tax (as compared to the usual 18% or 28% rates) on a “material disposal of business assets”.  A material disposal includes the following:

• all or part of a business
• certain holdings of shares in a company

The main conditions for a disposal of shares in a company are:

• The company must be a trading company or holding company of a trading group.
• The shareholder must be an officer or employee and hold at least 5% of the ordinary share capital and at least 5% of the voting rights.

There are a number of conditions relating to the disposal of a business interest.

In order to qualify for ER, an individual taxpayer has to meet all qualifying conditions for one year. For shareholdings this means that the shares will need to be held for at least a year in order to qualify.  Not all business disposals will qualify for ER, so it is important to check that the conditions are met, not just initially, but on an ongoing basis to ensure that the eventual disposal will qualify.

Employee Ownership/Share Schemes

Employee ownership is an increasingly popular way of attracting, not just financial investment, but commitment and potentially improved growth for a business. Many businesses look for and struggle to obtain external investment without even considering employee ownership, which could be a realistic and incentivising option.

There are a number of tax efficient ways for employees to buy into a company, including EMI, Share Incentive Plans and Approved & Non-Approved Share Schemes. These may not always result in an immediate cash injection, so may need to be used in conjunction with one of the other options above.  Each scheme has its own complex set of rules so specialist advice should be taken to ensure the scheme conditions are met, the scheme continues to qualify and does not conflict with any other schemes already in place, such as EIS.

Conclusion

Whilst tax should not be the only driver in any business decision, offering investors a tax efficient option may make all the difference. There are a number of options available depending on the requirements of the investor.  In the current economic environment, businesses need to offer investors tax efficient options to stand the best chance of securing investment.

Sarah Brock can be contacted at:  sarah@wardwilliams.co.uk