EIS, VCT and SEIS

Author Image The Technical Team
17 minutes read
Last updated on 6th Apr 2019

Overview

Learn about venture capital trusts, enterprise investment schemes and seed enterprise investment schemes and the tax reliefs available to investors.

Key points

  • Investment vehicles that attract income tax relief for individual investors as well as capital gains tax exemption.
  • EISs, VCTs and SEISs encourage investment into small unquoted trading companies.

What are EIS, VCT and SEIS?

The enterprise investment scheme (EIS) and venture capital trust (VCT) have traditionally been grouped together because they encourage investment in small, unquoted trading companies and have certain legislative features in common. For these purposes, shares on the Alternative Investment Market (AIM) are considered unquoted. Most trades qualify, but some which are termed 'excluded activities' do not. For example, dealing in land or commodities, financial activities and property development are all excluded activities. A company can carry on some excluded activities, but these must not be 'substantial', which HMRC takes to mean as more than 20% of the company's activities.

The EIS is designed to help these small companies raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.

The VCT scheme spreads the investment risk over a number of companies since individuals invest indirectly in a range of small companies. Investors subscribe for shares in VCTs, which are companies listed on the London Stock Exchange and are similar to investment trusts. VCTs are run by fund managers who are usually members of larger investment groups. From time to time, VCTs realise investments and make new ones. Individuals may now subscribe for shares in a VCT via a nominee.

With regard to the qualifying rules for these small unquoted trading companies, there were changes effective from April 2012 which:

  • increased the maximum number of employees to 249 (from 49)
  • increased the maximum total gross assets before investment to £15 million (from £7 million)
  • increased the maximum total gross assets after investment to £16 million (from £8 million)
  • increased the annual amount raised by an individual company to £5 million (from £2 million)
  • removed the £1 million limit on investment by a VCT in a single company.

The government announced in the 2011 budget that it would consult on options to provide new support for seed investment. As a consequence the seed enterprise investment scheme (SEIS) was introduced from 6 April 2012 to encourage investment in new start-up companies. In the 2014 budget, the government announced that the SEIS was being made permanent.

In the 2015 budget, the government announced an amendment to tax-advantaged venture capital schemes. There were a number of revisions including:

  • in addition to the existing cap on annual investments of £5 million, a new cap applies on the total amount of investments a company may raise under EIS, VCT or other risk finance investment, of £15 million, except for knowledge-intensive companies
  • For knowledge-intensive companies, the cap on the total amount of investments is £20 million, and the limit on employees is raised from 250 to 500 employees.

It was announced in the 2015 autumn statement that effective from 30 November 2015, the provision of reserve energy generating capacity and the generation of renewable energy benefiting from other government support by community energy organisations are no longer qualifying activities for VCT or social investment tax relief.

In the 2017 budget, the government announced new qualifying conditions based on a principal based test which will be used to determine if the company is a genuine entrepreneurial company.

The measure introduces a new condition to the EIS, SEIS and VCT rules to exclude tax-motivated investments, where the tax relief provides most of the return for an investor with limited risk to the original investment (that is, preserving an investor’s capital). The condition depends on taking a ‘reasonable’ view as to whether an investment has been structured to provide a low risk return for investors.

The condition has two parts: whether the company has objectives to grow and develop over the long-term (which broadly mirrors an existing test with the schemes); and whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return. The condition requires all relevant factors about the investment to be considered in the round. 

Comparison table

 

 

EIS 2018/19

EIS 2019/20

VCT 2018/19

VCT 2019/20

SEIS 2018/19 & 2019/20

Income tax

 

 

 

 

 

Maximum investment

£2,000,000*

£2,000,000*

£200,000

£200,000

£100,000

Tax relief

30%

30%

30%

30%

50%

Holding period

3 years

3 years

5 years

5 years

3 years

One year carry back

Yes

Yes

No

No

Yes

Dividends

Taxable

Taxable

Exempt

Exempt

Taxable

Capital gains tax

Gains exempt after 3 years

Gains exempt after 3 years

Gains exempt

Gains exempt

Gains exempt after 3 years

Capital gains tax deferral relief

Yes

Yes

No

No

No

Capital gains tax holiday

No

No

No

No

Yes

*increased limit only if anything above 1 million is invested in knowledge-intensive companies.

EIS income tax relief

Income tax relief is covered in Part 5 Income Tax Act (ITA) 2007.

This is available to individuals only, who subscribe in cash for newly issued full-risk ordinary shares in a qualifying company. Investment can be directly into the company, or through an EIS fund, which will invest on behalf of the individual in a number of qualifying companies. The subtleties of EIS funds are not considered further but it should be noted that the individual is still the owner of the shares.

The minimum investment is £500 worth of shares in any one company in any one tax year. The maximum investment on which relief can be obtained is currently £2,000,000.

For shares issued from 6 April 2011 the relief is 30% of the cost of the shares, to be set against the individual's income tax liability for the year of assessment in which the shares are issued. The maximum tax reduction in any one year is therefore £600,000, providing a sufficient income tax liability exists to cover it.

Relief is also available in the case of joint subscriptions. Where shares are held jointly each of the owners is treated as having subscribed an equal amount even if all of the funds were provided by one of them.

There is a 'carry back' facility, which allows all or part of the cost of shares acquired in one tax year to be treated as if acquired in the preceding tax year, with relief then given against the income tax liability of that preceding year.

Example

Chris subscribes £900,000 for shares issued on 10 October 2019. He has already had relief of £600,000 in 2018/19, and the maximum relief available for that year is £1,000,000, so he elects to carry back £400,000 to 2018/19. He uses the balance of £500,000 in 2019/20.

Chris will be required to make two separate claims.

Income tax relief can’t be claimed if the individual is connected with the company in either of two ways. Firstly, by financial interest – for example the individual or an associate holding more than 30% of the share capital. Secondly, by employment – a partner, director (except for business angels) or an employee is deemed connected (an associate is so connected).

Example

George subscribes for a 15% stake and obtains income tax relief. One year later he subscribes for an additional 20%. He is then deemed connected and his relief will be withdrawn.

Prior to claiming relief, an investor must receive from the company form EIS3, which certifies that the company has not, so far, breached any of the conditions for being a qualifying company. Form EIS3 cannot be issued unless the company has been trading for at least four months.

Income tax relief is then typically claimed on the self-assessment tax return for the tax year in which the shares were issued. If the shares were issued in a previous year, and / or if the claim is for capital gains deferral relief, the claim part of the form EIS3 must also be completed and submitted to HMRC.

Investors who don’t make returns under self-assessment can use the claim section of form EIS3 to make their claim.

EIS withdrawal or reduction of income tax relief

EIS shares must be held for three years from the date of issue or the start of trade if later, otherwise income tax relief will be withdrawn.

Relief will be withdrawn, if during that period: 

  • the investor or an associate become connected with the company
  • the company loses its qualifying status. Genuine commercial liquidation would not result in withdrawal of relief.

Relief will be reduced or withdrawn if, during that period: 

  • any of the shares are disposed of (unless the disposal is to a spouse or civil partner at a time when the couple are living together)
  • the investor or an associate 'receives value' from the company (eg receives a loan or benefit from the company). 

EIS disposal relief – capital gains tax exemption

If an investor has received income tax relief (which has not subsequently been withdrawn) on the cost of the shares, and the shares are disposed of after they have been held for the three-year period, any gain is exempt from capital gains tax (S150A TCGA 1992). The exemption may be restricted if: 

  • the investor has oversubscribed
  • the investor has received value from the company and the income tax relief has been reduced accordingly.

There is no restriction if the only reason full income tax relief cannot be given is because the claim reduces the investor's income tax liability to nil.

If income tax relief is not claimed, then any subsequent disposal of the shares will not qualify for exemption from capital gains.

An investor can claim a capital loss on the disposal of EIS shares (whenever disposed of) but in calculating this loss, the allowable cost is reduced by income tax relief not withdrawn. 

Example

An investor subscribes £100,000 for 50,000 shares in an EIS company. Income tax relief of £30,000 is given.

Five years later these shares are sold for £65,000

The allowable loss is calculated as follows:

Disposal proceeds

 

£65,000

Less cost

£100,000

 

Reduced by income tax relief

(£30,000)

£70,000

Allowable loss

 

£5,000

EIS disposal relief – income tax relief for capital losses

If the shares are disposed of at a loss, the investor can elect that the amount of the loss, less any income tax relief not withdrawn, can be set against income of the year in which the shares were disposed of, or any income of the previous year, instead of being set off against any capital gains (S131 ITA 2007).

EIS capital gains tax deferral relief

This relief is covered in Sch 5B Taxation of Chargeable Gains Act (TCGA) 1992.

Deferral relief can be claimed against any amount of chargeable gain arising on the disposal of any asset where the gain is invested in EIS shares. It can also be claimed when a gain previously deferred under the EIS (or VCT shares issued before 6 April 2004), is brought back into charge. The investor can claim deferral relief on only part of the gain if desired. The effect is to defer the tax liability until the EIS shares are sold or deemed sold. The investment must be made within the period one year before or three years after the gain arose.

To qualify, the investor must be an individual (or the trustees of a qualifying settlement) who is resident in the UK both at the time the gain accrued and at the time the shares are issued. Note however that EIS income tax relief and CGT disposal relief are not available to trustees.

The relief is claimed by the investor submitting part 2 of the EIS3 certificate from the company. The time limit for claiming is five years from 31 January following the end of the tax year in which the shares were issued.

The deferred gain becomes chargeable when there is a chargeable event. For example, 

  • a disposal of the EIS shares (except a disposal to a spouse or civil partner which is covered by the no gain/no loss rule) 
  • the investor becoming non-resident within the three-year period (unless by reason of temporary overseas employment)
  • the company ceases to be a qualifying company.

A disposal of some of the shares would trigger a proportion of the deferred gain becoming assessable.

A deferred gain is not triggered on the death of the investor or the spouse/civil partner who acquired the shares on a no gain/no loss transfer. 

It doesn’t matter whether the investor is connected with the company or not. It is therefore possible for an individual to invest in a company which he already owns or controls.

EIS and the company

For investors to be able to claim, and keep tax reliefs, the issuing company has to meet the qualifying rules as referred to in the introduction throughout the three-year period. Note however that the company may subsequently become quoted without investors losing relief, but only if there were no arrangements for it to become quoted in existence when the shares were issued.

VCT tax reliefs available


Tax reliefs are only available to individuals aged 18 years or over and not to trustees, companies or others who invest in VCTs.

For individuals who subscribe for new ordinary VCT shares, three tax reliefs are available.

  1. 'front-end' income tax relief.
  2. exemption from CGT on disposals.
  3. exemption from income tax on dividends.

For individuals who don’t subscribe but acquire by other means (eg purchase from someone else) then tax reliefs 2 and 3 are available.

CGT deferral relief, previously available, was abolished in respect of shares issued after 5 April 2004.

In the 2015 budget, the government announced an amendment to the VCT legislation to ensure that from 6 April 2014, notwithstanding the general time limits for making assessments to recover tax, HMRC can withdraw tax relief if VCT shares are disposed of within five years of acquisition.

A further announcement in the 2014 budget was that the government were to prevent VCTs from returning capital that does not relate to profits on investments within three years of the end of the accounting period in which shares were issued to investors. This took effect in respect of shares issued on or after 6 April 2014.

VCT income tax reliefs

Income tax relief is covered in Part 6 of ITA 2007.

'Front-end' tax relief is available at 30% of the cost of new ordinary shares subscribed for up to the 'permitted maximum' of £200,000, to be set against the individual's income tax liability for the year of assessment in which the shares are issued. The annual limit applies to all the taxpayer's acquisitions in VCTs in the tax year concerned, and shares acquired earlier in the tax year count towards the permitted maximum first.

The maximum tax reduction in an individual's income tax liability in any one year is therefore £60,000, providing a sufficient income tax liability exists to cover it.

Example

If Jonny subscribed £20,000 for shares, his maximum income tax relief would be £6,000. If his actual liability in that year before any VCT tax relief was £5,000, then that is the relief he would receive. The difference of £1,000 can’t be set off against the income tax liability of any other year.

The shares must be held for at least five years and throughout this time carry no present or future preferential rights to dividends or to the VCT's assets on winding up and no present or future rights to be redeemed.

Tax relief can be claimed either with the tax return (see page Ai 2) or as a standalone claim. There is no set form for a standalone claim.

Dividends received from VCT shares are exempt from income tax ('dividend relief') in respect of shares acquired within the 'permitted maximum' of £200,000. These dividends do not have to be included in the tax return.

VCT withdrawal of front-end income tax relief

'Front-end' income tax relief will be withdrawn, in whole or in part, if the shares are disposed of within five years of issue. A disposal between spouses or civil partners who are living together does not give a rise to a withdrawal.

Example

Ed subscribes £100,000 for 100,000 VCT shares. He claims front-end income tax relief of £100,000 x 30% = £30,000. Within five years he sells 10,000 shares at arm’s length for £2,000.
The front-end income tax relief to be withdrawn is the smaller of:

a. relief given on shares disposed of £30,000 x 10,000 / 100,000 = £3,000, and
b. consideration £2,000 x 30% = £600.

The relief to be withdrawn is therefore £600.

Front-end relief may also be withdrawn where a VCT loses its approval. Death doesn’t give rise to a withdrawal of front-end income tax relief.

VCT refreshing income tax exemption

Investors are now prevented in certain circumstances from refreshing income tax relief on investments into VCTs by disposing of VCT shares and reinvesting the proceeds in new shares. Relief is restricted where there is a ‘linked sale’.

A sale is ‘linked’ if an individual has sold shares in the same VCT as the VCT in which the investor has subscribed for shares, or in a VCT which is treated as a successor or predecessor of that VCT, and either the subscription for shares is in any way conditionally linked with the share sale, or the subscription and sale are within six months of each other.

The amount subscribed on which income tax relief may be claimed will be reduced by the amount of consideration the investor receives for a sale of shares ‘linked’ to the subscription.

A sale is linked where the individual sold shares in the same VCT as the VCT subscribed, or in a ‘successor’ or ‘predecessor’ VCT, and either the subscription is in any way conditionally linked, or the subscription and sale are within 6 months of each other. ‘Successor’ and ‘predecessor’ VCTs are defined in new section 264A(7) ITA 2007.

The measure does not affect subscriptions for shares where the monies being subscribed represent dividends which the investor has elected to reinvest.

The restrictions affect claims to relief for investment in VCT shares, by reference to shares issued on or after 6 April 2014.

VCT capital gains tax exemption

There will be no chargeable gain (or allowable loss) for CGT purposes on selling ordinary shares in a VCT provided: 

  • the shares were acquired within the permitted maximum for the tax year in question.
  • the VCT was approved as a VCT both when the shares were acquired and when they were sold.

There is no minimum period for which the shares must be held.

As for 'dividend relief', CGT relief is available for both newly issued shares and second-hand shares. 

VCT conditions for HMRC approval

The conditions a company must satisfy for it to be approved as a VCT include:

  • income is wholly or mainly from shares or securities

  • at least 70 per cent, by value, of its investments comprise holdings in qualifying companies (see introduction)

  • the holding in any company must not represent more than 15% (by value) of its investments

  • its ordinary shares are listed on the London Stock Exchange

  • it must not retain more than 15% of the income it derives from shares or securities.

Seed investment enterprise scheme (SEIS)

This scheme:

  • applies to companies with 25 or fewer employees; assets of up to £200,000, and which are carrying on or preparing to carry on a new business

  • gives income tax relief worth 50% of the amount subscribed by individual investors with an investment of less than 30%, including directors who invest in their companies.

  • has an annual investment limit of £100,000 per investor, with unused annual amounts able to be carried back to the previous year, as under the EIS

  • has an overall tax favoured investment limit of £150,000 for the company. This is a cumulative limit, not an annual limit. Exempt CGT on gains on SEIS shares.

Exempted CGT on gains realised from disposals of assets in 2012-13, where the gains were reinvested in shares that qualified for SEIS income tax relief. The amount invested could be set against chargeable gains subject to a £100,000 investment limit. The relief was extended to gains realised on disposal of assets in 2013/14 but only half (rather than the whole) of the reinvested amount could be set against chargeable gains. CGT reinvestment relief remains a permanent feature, providing relief on half the qualifying gains that individuals reinvest in SEIS qualifying companies in 2014/15 and subsequent years.

Planning

These schemes offer significant tax incentives to investors willing to take the investment risk involved with unquoted trading businesses. That risk is mitigated with an EIS investment due to the ability to obtain income tax relief for capital losses.

Example:

Polly who is a 45% additional rate taxpayer invests £200,000 in an EIS company in 2018/19. Her income tax liability is reduced by £200,000 x 30%= £60,000.

In 2020/21 the company ceases trading and it is agreed by HMRC that the shares are of negligible value. Polly claims income tax relief in that year as follows:

Proceeds

 

£ Nil

Less cost

£ 200,000

 

Reduced by income tax relief

(£ 60,000)

£ 140,000

Loss

 

£ 140,000

Reduction in income tax liability £ 140,000 x 45% £ 63,000

Original investment

£ 200,000

Total tax relief £ 60,000 + £ 63,000

£ 123,000

Net cost

£ 77,000

In addition, an EIS investment can also qualify for 100% inheritance tax (IHT) relief under business property relief (BPR) rules. This will only apply however if the BPR conditions are met.

The same IHT consequences apply to SEIS shares.

Labelled Under:
Investments

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