Tax relief for investors
- Veronika Lipinska
- Updated: Thu, 11th May 2017
SEIS or Investor’s 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. EIS is the big brother of SEIS, with similar rules.
To help you make decisions we have set out below:
In a nutshell Investor’s Relief extends Entrepreneurs Relief for investors by removing the requirement to work in the business. But, SEIS/EIS is more generous. Generally speaking SEIS is more suitable for minority shareholders in start-up companies. Investor’s Relief will work for larger investors in mature companies. We consider the structure for investments into a range of businesses with a focus on start ups in the IT sector.
Overview of the differences
Both Investors’ Relief and SEIS apply to individual investors, not companies or partnerships.
SEIS and EIS key conditions for investors
Key conditions investors include:
- There are maximum investment levels;
- There must be no reciprocal arrangements between the investor and the company;
- The investor cannot have a “substantial interest” in the company. Substantial is usually an interest of more than 30%;
- The trade has to qualify – this rules out businesses involving investment such as property and finance along with certain professional services; and
- The investor cannot hold preferential shares.
So, many investors cannot claim tax relief under SEIS or EIS as they fall at one of the hurdles. The question then becomes can they qualify for 10% CGT on sale under Investor’s Relief?
Flexibility of Investor’s Relief
The rules are much more flexible. For example:
- There is no minimum or maximum investment level;
- The investor can lend money to the company and receive interest at commercial rates;
- The investor can control a substantial interest;
- No restrictions on the type of trade undertaken providing that no more than 20% of the trade relates to investment activities; and
- The investor can hold preference shares.
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 Investor’s 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:
|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
|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
|Who can invest?||Individual investor||Individual 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
|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
|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.|
|Income tax relief||Not applicable.||Upfront 50% reduction in income tax liability up to an investment limit of £100,000.|
|Capital gains relief||Capital 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 relief||The 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.|
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