HMRC denial of EIS relief

Not every company qualifies for tax relief for its investors under the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS). Unfortunately, some companies only discover this after shares have been issued. Below, we explain some circumstances in which investors may be denied EIS relief.

EIS denied because of preferential rights given to some shareholders

Abingdon Health Limited [2016] TC 05525 concerned the creation of growth shares for company directors.

The company raised finance through three rounds under EIS. After the second round and before the third, a new class of shares, known as growth shares, was created for the directors.

HMRC had authorised EIS relief for the first two share issues but later withdrew it. An amendment to the Articles of Association gave holders of EIS shares a preferential right to the company’s assets on a winding-up, because equivalent rights did not attach to the growth shares.

The taxpayer appealed, arguing that the preferential right was purely theoretical.

HMRC won and all investors refused EIS relief

The tribunal found in HMRC’s favour, and investors were denied EIS relief on their investments. The withdrawal affected investment rounds issued both before and after the growth shares were created.

• To qualify for EIS, shares must not carry any present or future preferential right to the company’s assets on a winding-up.
• The tribunal treated this as a strict test: the prohibited right either existed or did not. There was no de minimis exception.
• The fact that the advantage was contingent or theoretical did not prevent the shares from being disqualified.

EIS denied because not all subsidiaries qualified

Hunters Property plc v Revenue and Customs Commissioners (First-tier Tribunal (Tax Chamber), 23 February 2018) concerned an acquisition involving a company limited by guarantee. The company had no share capital, was not trading and had a limited purpose. A Hunters director was appointed to its board and placed in sole charge.

Outcome - HMRC won and all investors refused EIS relief

HMRC successfully argued that the investors were not entitled to EIS relief because one company in the group did not meet the qualifying conditions.

The tribunal found that Hunters controlled the company limited by guarantee. It also concluded that a company without share capital could not qualify as a “51% subsidiary” under the relevant EIS rules.

The case illustrates the importance of checking the structure and activities of the entire group when assessing EIS eligibility.

EIS denied because of a Special Purpose Vehicle (SPV)

The statutory risk-to-capital condition, introduced in 2018, requires an investment to satisfy two requirements:

1. The company must have objectives to grow and develop its trade in the long term.
2. The investment must carry a significant risk that investors will lose more capital than they gain as a return.

Both conditions must be satisfied for EIS relief to be available.

Demonstrating growth and development for EIS purposes

A company seeking EIS advance assurance should be able to demonstrate its intention to grow and develop its trade over the long term. Evidence may include plans to increase:

• Revenue;
• Customer numbers; or
• The number of employees.

These are examples of relevant evidence, rather than an exhaustive statutory checklist.

Demonstrating high risk for EIS purposes

HMRC may deny relief if the investment does not carry a significant risk that investors will lose more capital than they gain as a return. The assessment depends on the company’s circumstances and the nature of the investment.

Why will HMRC deny EIS relief for SPVs?

An SPV is a legal entity created for a specific purpose. SPVs are used in industries such as property and film, and may be established to:

• Acquire a business;
• Finance a project; or
• Establish a joint venture.

Many SPVs are subsidiaries of holding companies. The EIS rules restrict relief in certain circumstances where a company is controlled by another company, subject to the applicable statutory conditions and exceptions. A holding company’s eligibility does not automatically mean that an SPV within its structure will qualify.

SPVs may struggle to satisfy the risk-to-capital condition because their activities are often limited to a single project. For example, an SPV established to develop a property may have limited scope for continued growth once the project is complete, particularly if its business plan involves reducing its workforce as the project approaches completion.

If an SPV cannot demonstrate a genuine intention to grow and develop its trade over the long term, or fails to meet the separate investment-risk requirement, EIS relief may be denied.