SEIS and EIS rules for startup investors

The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are two of a number of UK government initiatives which encourage innovation by granting private investors a significant tax break when investing in early stage, ‘high-risk’ companies.

Here is a more in-depth overview of the SEIS/EIS Schemes.

As an investor, in order to benefit from SEIS/EIS in your investments, you need to ensure that (i) the company you are investing in and the shares you receive in exchange for your investment are SEIS/EIS eligible, and (ii) you as an investor are eligible for these schemes – otherwise your tax breaks may be denied or reduced by HMRC.

Regarding the company you are investing in, you should ask them for proof of Advance Assurance letter from HMRC. It’s a document that shows HMRC agrees an investment in the company is SEIS/EIS eligible. However, the Advance Assurance will not tell if you, as an investor, would meet the conditions for these schemes.

In this article, we will cover:

• Investor rules for SEIS
• Investor rules for EIS

Investor rules: SEIS

1. Have UK income (but not necessarily live there)

You don’t need to be a UK resident to claim SEIS, but you must have UK income tax liability against which to set the relief. The shares must be held for a period of at least three years from the date of issue for the relief to be retained. If they are disposed of within that three year period, or if any of the qualifying conditions cease to be met before the termination date for the shares (3 years from the date of the share issue), relief may be withdrawn or reduced.

2. Not a company employee – but you can be a paid director

The investor and any ‘associates’ must not be an employee of the company as from the date of issue of the shares and up to the third anniversary of the date of the share issue. An ‘associate’ includes business partners, trustees, and relatives (spouses, civil partners, parents, children, etc.). Brothers and sisters are not considered as associates for SEIS purposes.

However, you can be a director, and receive reasonable compensation for this position.

Full details in this HMRC article.

3. No substantial interest in the company

The investor must not have any ‘substantial interest’ in the issuing company at any time from incorporation of the company until the third anniversary of the date of the share issue (or for EIS two years before the date on which the shares are issued if that is later). For SEIS ‘Substantial interest’ is defined as the investor directly or indirectly possessing, or having an entitlement to acquire more than 30% stake in the company. Shareholdings of associates are taken into account in arriving at the 30% figure. For EIS this value is also 30 %.

4. No related investment arrangements

An investor will not qualify for SEIS relief if he has subscribed for the shares as part of a reciprocal arrangement which involves somebody else subscribing for shares in a company in which the investor has a substantial interest in return for the investor subscribing in a company in which the other person has a substantial interest.

5. No linked loans

No loans should be made to the investor or their associates which are linked to their subscription for shares at any time from the incorporation of the company until the third anniversary of the date of the share issue. This includes cases where credit is given or a debt due from the investor or associate is assigned.

6. No tax avoidance

An investor in a company is not eligible for SEIS relief unless the subscription is made for genuine commercial reasons and not as part of a scheme or arrangement the main purpose or one of the main purposes of which is the avoidance of tax.

7. Limit on relief

An individual investor is limited to investing £100,000 per year for SEIS in exchange for a 50% tax break and a capital gains tax exemption on any profits that arise from the sale of shares after three years.

However, SEIS investments also offer a “carry back” facility. This means SEIS eligible investors can opt for all or part of their SEIS shares acquired in the current tax year to be treated as though they had been acquired in the previous one – providing they have not used up their SEIS allowance in the previous tax year. As an example, say you wanted to invest £150k in a startup in the 2021 tax year, and had not used up any of your allowance in the 2020 tax year, then you could “carry back” £50k’s worth of investment to the previous year and still claim SEIS for the whole £150k investment!

8. Withdrawal or reduction of the relief

Tax relief under SEIS may be either withdrawn or reduced if:

1. at any time during the three years from the date of issue of the shares, the investor disposes any of the shares (a disposal to a spouse or civil partner does not count towards a disposal);
2. the investor receives ‘value’ from the company or from a person connected with that company at any time from the incorporation of the company to the third anniversary of the date of the share issue. The circumstances during which an investor is deemed to have received value from the company include situations where the company repays, redeems or repurchases any of its share capital belonging to the individual, the company repays a debt owed to the individual, the company provides a benefit or facility for the individual, etc. If you are unsure about whether you have received ‘value’ from the company, you can consult with the clarifications made by HMRC.
3. there is a put option or call option over the shares at any time before the third anniversary from the date of the issue of the shares.

Finally, it is important to note that apart from the above requirements relating to the investor, an investor will not be able to claim his or her SEIS tax relief if the company ceases to meet the qualifying conditions and/or fails to spend the money raised by the share issue as required.

Investor rules: EIS

1. Residency

To be able to benefit from income tax relief under EIS, the investor must be an individual who need not be a UK resident but must have UK income tax liability against which to set the relief. The individual must make the subscription on his or her own behalf, and may use another person as a nominee to subscribe for the shares or invest under a joint subscription.

2. No ‘connection’ with the issuing company

The investor must not be connected with the company as from the time of the incorporation of the company, or two years before the date on which the shares are issued if that is later, to the third anniversary of the date of the issue of the shares, or the third anniversary of the date on which the company begins to carry on a qualifying business activity if it has not begun to carry on that trade on the date of issue of the shares. An individual is deemed as having a ‘connection’ with the issuing company if he or she, or any associate of them, is:

– An employee, or

– A partner, or an employee of a partner, or

– A director (except from cases where the director receives, or is entitled to receive, remuneration). This restriction is tightly drawn by the legislation, so if you or an associate of yours has been a director of the company you should consult with HMRC’s guidelines.

– A director of a company which is a partner of the company, or of any company which is at any time as from the incorporation of the company, or two years before the date on which the shares are issued if that is later, is a subsidiary of that company.

If you are unsure about the above, please visit the extensive explanation provided by HMRC.

An individual is connected with a company if he or she, whether alone or together with any associate (i.e. spouse, civil partner, parent, child, not including brothers and sisters), directly or indirectly possesses or is entitled to acquire more than 30% of the ordinary share capital of the company or any subsidiary.

3. No receipt of a loan

The investor or any associate must not have received a loan by the company which would not have been made, or would not have been made on the same terms, were it not for the EIS investment, as from the incorporation of the company, or two years before the date on which the shares are issued if that is later, up to the third anniversary of the date of the issue of the shares, or if the money raised by the company was for the purpose of a trade and the company has not begun to carry on that trade on the date of issue of the shares, the third anniversary of the date on which the company begins to carry on the trade in question.

4. No tax avoidance

An investor in a company is not eligible for EIS relief unless the subscription is made for genuine commercial reasons and not as part of a scheme or arrangement the main purpose or one of the main purposes of which is the avoidance of tax.

5. Limit on relief

There is a limit on the amount on which relief can be obtained for any year of the assignment. The maximum amount for 2018-19 onwards is £1 million, or £2 million so long as any amount over £1 million is invested in one or more knowledge-intensive companies. Like with SEIS, EIS investments also offer a carry back facility.

6. Withdrawal or reduction of EIS relief

In general, there may be a complete withdrawal of any relief attributable to shares if, by reason of some event, any of the condition for the EIS relief ceases to be satisfied. Such situations include (i) where the shares issued by the company are not eligible shares, (ii) the individual is not a qualifying individual, (iii) the company is not a qualifying company, (iv) the company has failed to comply with the time limits for employing the money raised by the issue.

The EIS relief may be reduced where during the relevant period (i.e. form the date of the issuance of the shares to the third anniversary of the date of issue of the shares):

1. The investor disposes of his or her shares,
2. The investor receives value from the company or a connected person (see above for a discussion around the ‘receipt of value’),
3. The company purchases any of its own shares from a member who has not had relief,
4. The investor disposes of any share capital or securities of the company to a person connected with the company.

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