SEIS vs Investors’ Relief

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SEIS vs Investors’ Relief

SEIS or Investors’ Relief is the choice facing investors in smaller start-up companies these days. Both SEIS & Investors’ Relief are tax efficient for passive investors, but the tax benefits differ. The EIS is the big brother of SEIS, with very similar rules, so isn’t discussed here. 

Investors Relief was announced in the 2016 budget. It extends Entrepreneurs Relief for business investors who don’t work in the business. It reduces an investors’ capital gains tax liability from 20% to 10%.

Who qualifies for Investor’s Relief vs SEIS

Both Investors’ Relief and SEIS apply to individual investors, not companies or partnerships.

SEIS conditions

Key conditions investors should satisfy for SEIS tax reliefs include:

  • The SEIS share issue must be for commercial reasons not tax avoidance purposes;
  • No reciprocal arrangements between the investor and the company;
  • The company cannot loan money to the investor and his associates for three years after the SEIS share issue;
  • The investor cannot have a “substantial interest” in the company at any point from company incorporation to the SEIS share issue’s third anniversary.
    • “Substantial interest” means 30% of share capital or
    • Voting rights or entitlement to 30% of company’s assets.

Investors’ Relief conditions

To qualify for Investor’ Relief, an investor cannot receive a ‘return of value’, i.e. indirect benefit from the company.  Generally, the qualifying conditions are less stringent that the SEIS conditions.

The investor can lend money to the company and receive interest at commercial rates.

SEIS vs Investor’s Relief qualification criteria

There are different qualification criteria for the size of the investment, whether employees can invest, the company’s activities, and the types of share.

Maximum investment

A company issuing SEIS shares can raise up to £150,000 during the first two years of trading. Each investor can invest up to £100,000.

There is no equivalent limit for Investors’ Relief.

Employee investors

To gain both reliefs, the investor must not be employed with the business at any time. Furthermore, to gain SEIS relief, the investors’ associates must not be employed. However, SEIS rules  permit an investor to be a director, either paid, or unpaid.  Note EIS qualifying conditions are different.

Which companies

The qualification criteria to obtain SEIS relief is tougher than to gain Investors’ Relief: To qualify for Investors’ Relief the company only needs to be a trading company. HMRC is not concerned with the nature of company’s activities, just that the company is trading. However, the company cannot have substantial non-trading activities, i.e. no more than 20% of company’s activities can be investment activities.

SEIS Relief

The qualifying criteria for the company for SEIS are more stringent. The company must be:

  • Unquoted;
  • Independent, i.e. must not be a 51% subsidiary of another company;
  • A trading company throughout the period from incorporation to the SEIS share issue’s third anniversary;

The company must:

  • Have traded for under 2 years;
  • Employ few than 25 employees;
  • Satisfy the “gross asset test”:
    • The issuing company’s gross assets can’t exceed £200,000 before shares are issued, or
    • The group’s gross assets if the company is a parent company.

The company must not be:

  • In financial difficulty;
  • Involved in excluded activities, e.g.
    • Farming,
    • Leasing, or
    • Receiving licence fees.

And:

  • There must be no previous EIS or VCT investment in the company;
  • The company’s subsidiaries must be qualifying 51% subsidiaries;

What shares qualify

To gain both reliefs, the shares need to be qualifying shares, fully paid up, full risk shares. Investors must hold the shares forat least three years.

Maximum/minimum shareholding

Investors’ Relief has no maximum shareholding. SEIS investors shareholding can’t exceeed 30% of the total. There is no minimum number of shares in either case.

Qualifying business activity

SEIS shares must be issued to raise money for a qualifying business activity. Investors’ Relief has no such requirement.

SEIS vs Investors’ Relief: Tax advantages

As a tax relief, SEIS is more generous than Investors’ Relief. A SEIS investor’s income tax liability is reduced by 50% of the sums invested, up to the annual investment limit, provided the shares are held for three years. The income tax relief can also be carried back by a year, which can reduce income tax liability for two tax years. Any gain on the sale of SEIS shares is exempt from capital gains tax.

Investors’ Relief applies only on the sale of shares and lowers the capital gains bill to 10%. It does not reduce income tax.

Both Investors’ Relief and SEIS must be claimed on the individual’s tax return. In order to get SEIS relief the company needs to issue relevant forms to HMRC and receive forms to forward to the investor before the claim is made.

Amount of relief

There is a lifetime cap of £10 million on the amount of capital gains that qualify for Investors’ Relief. SEIS is subject to a £100,000 annual investment limit.

SEIS vs Investor’s Relief: Example

Max Smith is an angel investor working for a well known City of London bank.  In May 2016, he decided to invest £100,000 in Yogi Bar Ltd. Yogi Bar Ltd makes yoghurt covered cereal bars, that assist weight loss. Max negotiated a 10% stake in the Company for his investment, which he wants to structure tax efficiently. His choice, if he qualifies, is between Investors’ Relief or SEIS. Max’s annual tax liability is around £40,000.

Tax paid under SEIS

Max should qualify for SEIS because he has no prior interest in Yogi Bar Ltd and will own under 30% of issued share capital. He gains an immediate reduction of income tax and will pay no capital gains tax when he sells the shares.

Max claims a £50,000 (£100,000 * 50%) income tax liability reduction. Because his income tax liability is £40,000 per annum he spreads the reduction over two years (£40,000 in year 1 and £10,000 in the previous tax year). If he sells his shares in 2020/21 for £200,000 the gain is exempt.

Max’s tax liability will be as follows:

Tax year2015/162016/172017/182018/192019/202010/21
Initial income tax liability ‘000£40£40£40£40£40£40
Actual income tax liability (50%) ‘000£30£0£40£40£40£40
Capital gains tax liability ‘000£0£0£0£0£0£0

Tax paid under Investors’ Relief (available from 2020/21)

Alternatively, Max will qualify for Investors’ Relief and will be able to claim this from tax year 2020/21. There will be no income tax relief available. Capital gains tax will be charged at 10% on disposal of the shares after three years ownership provided other criteria have also been met.

If Max’s income tax bill is £40,000 per annum and his shares have doubled in value his tax liability will look as follows

Tax year2015/162016/172017/182018/192019/202010/21
Initial income tax liability ‘000£40£40£40£40£40£40
Capital gains tax liability ‘000£0£0£0£0£0£8.84

SEIS vs Investor’s Relief: comparison summary

Our comparison of both tax reliefs:

Conditions relating to the Investor

Investors’ ReliefSEIS
Who can invest?Individual investorIndividual investor
Can the investor be employed at the Company?No. He can’t be an employee or a director.No. But he can be a director (paid or unpaid).
Can the investor have prior interest in the Company?Yes.Yes. The investor can hold up to 30% of Company’s shares or assets prior to the issue of shares (together with associates of the investor).
How much can be invested?Unlimited amount.SEIS is subject to an overall investment limit of £150,000. The maximum amount per investor per year is £100,000.
Can an investor loan money to the Company?Yes. There is no prohibition on loans.No. There must be no reciprocal arrangements or loans between the investor and the Company for three years after the Company has issued the shares to the Investor.

Conditions relating to the Shares

Investors’ ReliefSEIS
What shares?Ordinary shares. The shares must be issued on of after 17 March 2016 in exchange for a cash payment. They need to be fully paid up. The shares can’t be issued at an undervalue and must be issued for commercial reasons.Ordinary, full risk, fully paid up shares.
How long do the shares need to be held for?At least 3 years.At least 3 years to fully benefit.
Minimum shareholding requirement?No.No.

Conditions relating to the Company

Investors’ ReliefSEIS
Can all companies benefit from the relief?No. Just private unquoted companies.No. Just private unquoted companies.
Does the company need to be trading?The Company must be a trading company or a holding company of a trading group. Whether the company is trading is a question of fact. The company is not allowed to have substantially non-trading activities.The issuing company must meet the trading requirement throughout the period starting with its incorporation and ending on the third anniversary of the relevant share issue.
Do all trades qualify?Yes.No. Certain trades are prohibited, for example: coal-mining, legal and accountancy services, receiving royalties and licence fees, hotels and nursing homes.
Gross asset test?Not applicable.The value of the issuing company’s gross assets (or if the issuing company is a parent company, the group’s gross assets) must not exceed £200,000 immediately before the shares are issued.
Independence requirement?Not applicable.Yes. The Company must not be a 51% subsidiary of another company or under control of another company at any time from incorporation to the third anniversary of the share issue.
Is purpose of the investment relevant?Not applicable.Yes. The shares must be issued to raise money for the purposes for the qualifying business activity.
Does the investment need to be spent?No.Yes. The investment money need to be spent within three years of the share issue.
The Company has subsidiaries. Does it matter?No.Yes. All the subsidiaries must be qualifying subsidiaries. That means they must be owned 51% of the issuing Company. If any subsidiary is a property managing subsidiary it must be a 90% subsidiary of the issuing Company.
Maximum number of employees?Not applicable.25 full time employees.

Tax

Investors’ ReliefSEIS
Income tax reliefNot applicable.Upfront 50% reduction in income tax liability up to an investment limit of £100,000.
Capital gains reliefCapital gains tax payable at the sale of shares at 10%.No capital gains tax on the sale of the shares.
Cap£10m lifetime limit. This limit is separate from and additional to the lifetime cap on gains qualifying for entrepreneurs’ relief.There is a £100,000 investment limit in respect of any income tax relief per company per year.
Method of claiming the reliefThe relief is not automatic and must be claimed.The investor needs to submit forms to HMRC with his tax return.
Advance clearance available?Yes.Yes.

Summary

SEIS is the more generous of the two reliefs. However, you need to invest at an early stage, and ensure the company qualifies. SEIS is more suitable for minority shareholders in start-up companies.

Investors’ Relief will work for larger investors in mature companies. Please get in touch to discuss Investors’ Relief, SEIS and EIS.