Investor fails SEIS but secures EIS
Gannons advised an investor on how to make the best of his £60,000 investment.
We met with our client, who had just heard about the Seed Enterprise Investment Scheme, SEIS. He hoped he could essentially double his £60,000 investment in a start-up due to the 50% SEIS income tax relief on the cost of shares. We set our client on the right path to investment.
Our client had already loaned the business £60,000. However, the conversion from loan to equity would not meet the requirements for SEIS.
We proposed that the company use the funds invested by other third parties not under SEIS to repay the £60,000 loaned by our client. Once repaid, our client could use the money to subscribe for newly issued SEIS or Enterprise Investment Scheme (EIS) shares and secure tax relief.
The earlier in the process investors are aware of either EIS or SEIS relief, the more likely they will benefit from these tax reliefs. For a genuine third-party investment, early consideration of SEIS may save the investor over 50% in income tax relief. EIS investment tax relief is also available for larger, longer established companies with income tax relief at 30%.
The process we applied
We took our client through the qualifying criteria for SEIS.
We discussed the SEIS requirements. These include that the company needs to be unquoted, with fewer than 25 employees and less than £200,000 in gross assets. The company also cannot have had any investment from a venture capital trust, or be more than two years old. The company needs to be UK resident, and cannot receive more than £150,000 in total under SEIS. Finally, the company needs to be on the list of approved trades for SEIS.
Things started to look very hopeful. The company was very keen to complete the SEIS Advance Assurance Form then submit it to HMRC. Unfortunately, however, there were more hurdles to overcome. We discussed the complex substantial interest rules. An SEIS investor must hold less than 30% of the shares, including “Associates” shareholdings. Associates are business partners and relatives, but not siblings.
The SEIS rules are complex, as the Government sought to limit SEIS relief to genuine outside investors who finance high-risk start-ups. The rules prevent an obvious abuse of the system: a reciprocal arrangement where two shareholders invest in each other’s companies to obtain tax relief.
No SEIS relief for liquidation of loan
Then the bombshell hits: our client has already loaned the Company £60,000 and was expecting to be able to convert that loan into equity.
The share issue in consideration for the liquidation of a loan, or the ‘conversion’ of loan stock would not raise money for the company. Therefore, the shares would not be issued for a qualifying business activity. The shares would be in exchange for a pre-existing arrangement, i.e. the loan. Hence, the transaction becomes ineligible for SEIS tax relief.
The company lacked the funds to repay our client prior to the SEIS share issue. Our client also did not wish to further increase his investment.
Had our client understood the SEIS scheme, he could have injected £60,000 into the company for equity rather than as a loan in the first place.
A practical solution
Fortunately, we found a solution. Our client’s loan was for the benefit of the company’s trade. Raising cash via SEIS, and then using that cash to repay the loan, was only permitted if any money raised from was agreed by HMRC to be for the company’s organic growth and development. The company could, however, use the funds invested by other third parties not under SEIS to repay the original loan to our client.
When our client had been repaid, he could use the money to invest for newly issued EIS shares in a future share issue round anticipated for next year that was not connected to the repayment of his loan. The company could then continue to grow and attract investors via the qualifying investment schemes.