New Seed Enterprise Investment Scheme - Corporate Tax

Background

In the Autumn Statement on 29 November 2011 the Chancellor announced that the Government will introduce a new Seed Enterprise Investment Scheme ("SEIS") to encourage investment in new start-up companies. Subsequently, on 6 December 2011, the Government published a draft of Finance Bill 2012 that includes most (but not all) of the draft legislation concerning the SEIS.

The draft SEIS legislation is, of course, likely to be amended before it is enacted in Finance Act 2012. However, based upon the 6 December 2011 draft legislation, the key elements of the SEIS are outlined below.

Three new tax reliefs for individuals

The SEIS will provide individuals with up to three different tax reliefs.

Income tax relief for making the investment

The SEIS will provide a new income tax relief of 50 per cent for individuals who subscribe for new ordinary, non-redeemable shares in qualifying companies (see below).

Income tax relief at 50 per cent will be given whether or not the individual concerned pays 50 per cent income tax.

Each individual will have an annual investment limit of £100,000, but (provided the SEIS was in effect in the previous tax year) the individual can elect for some of the shares to be treated as acquired in the preceding tax year.

In principle, most individuals will be able to obtain tax relief under the SEIS. However, no tax relief will be available to:

A person who is, or is an associate of, an employee of the investee company (but for this purpose a Director of the company is not treated as an employee)
A person who has a "substantial interest" in the investee company. (This means, broadly, more than 30% of (i) the shares in the company, (ii) the voting power in the company or (iii) the assets of the company on a winding up).

The income tax relief cannot be claimed until the investee company has spent at least 70% of the money raised by the share issue for the purposes of the qualifying business activity for which it was raised and (in accordance with SEIS procedures) the investee company has issued a compliance certificate.

Capital Gains Tax exemption for disposal of qualifying shares

Capital gains subsequently realised by the individual on disposal of qualifying shares in the investee company will be wholly exempt from Capital Gains Tax ("CGT") provided the disposal occurs after the third anniversary on which the shares were issued by the investee company.

Tax relief for Capital Gains invested in SEIS

For the first year of the SEIS, i.e. the tax year beginning on 6 April 2012 and ending on 5 April 2013, there will be a one-off additional CGT relief for capital gains that are invested in the SEIS. In particular, a capital gain arising on the disposal of any kind of capital asset will be exempt from CGT if:

The capital gain arises on a disposal made on or after 6 April 2012 and before 6 April 2013
The capital gain is invested in new shares which are issued (fully paid up and wholly for cash) on or after 6 April 2012 and before 6 April 2013
The individual qualifies for income tax relief under SEIS in respect of that investment in new shares (see above), and
The new shares are held for at least three years after the date of issue.

The individual is not required to invest in the new shares the whole sale proceeds from the disposal: the capital gain will be fully exempt from CGT if only the capital gain is invested. For example, if an asset is sold for £200,000 and this realises a gain of £80,000, then the whole gain of £80,000 will be exempt from CGT provided the individual invests at least £80,000 in new SEIS-qualifying shares.

Further, the individual is not required to invest the whole capital gain, although in this case the CGT relief will be limited to that part of the gain which is invested in the new shares. Varying the above example, if only £20,000 of the £80,000 gain is invested in new SEIS-qualifying shares, then that £20,000 will be exempt from CGT, but the remaining £60,000 of the capital gain will remain subject to CGT (unless some other relief or exemption applies).

Which investee companies will qualify for SEIS?

As explained in the official Impact Assessment issued on 6 December 2011, the SEIS is intended to be focused narrowly upon "smaller, early stage companies carrying on, or preparing to carry on, a new business in a qualifying trade".

To achieve this narrow focus, there are numerous conditions, all of which must be satisfied, before a company can come within the SEIS. The relevant conditions include that:

The investee company must have been incorporated within two years ending on the date when the SEIS shares are issued. (This may discourage purchase of "off the shelf" companies from company formation agents)
The purpose of the existence of the investee company must be to carry on a trade which is a "genuine new venture"
The investee company must not control, or be under the control of, any other company
The investee company must not be a member of a partnership
The investee company must be an unquoted company
The investee company must have a UK permanent establishment
Immediately before the SEIS shares are issued, the gross assets of the investee company must not exceed £200,000

The SEIS shares must be issued wholly for cash and must be fully paid up at the time they are issued
At the time the SEIS shares are issued, the investee company must have fewer than 25 employees including Directors (although only the appropriate fraction of a part time member of staff is counted), and
No EIS investment or VCT investment has been made in the investee company on or before the day when the SEIS shares are issued.

A further significant restriction is that each investee company is subject to a cumulative investment limit, namely, that the total funds which it can raise from issuing SEIS shares is £150,000.

Tax anti-avoidance rules

As might be expected, the SEIS will be subject to numerous tax anti-avoidance rules, which comprise a substantial part of the draft SEIS legislation.

These rules, in some cases will:

Prevent SEIS relief being available at all in relation to the investee company (eg it has too many employees)
Prevent a particular individual investor from obtaining SEIS relief (eg the investor is an employee who is not a Director), and
Provide for the total or partial withdrawal of SEIS relief that has previously been given (eg if the SEIS shares are sold within three years of issue).

These extensive anti-avoidance rules are outside the scope of this summary note but, clearly, would need to considered carefully in each particular case.

Relationship between SEIS and the Enterprise Investment Scheme

An investee company that has raised funds through an issue of SEIS shares will be permitted subsequently to raise funds under the existing Enterprise Investment Scheme (EIS). The EIS rules will, however, be changed so that:

The investee company cannot issue any EIS shares until it has spent at least 75% of the funds it raised from the previous SEIS share issue, and
The maximum annual amount which the investee company is permitted to raise under the EIS will take into account funds raised under the SEIS.

Commencement and duration of the SEIS

Although, in due course, the life of the SEIS may be extended, it is currently intended that the scheme will apply for a five year fixed period, namely, to shares issued on or after 6 April 2012 and before 6 April 2017.

Comments

The new SEIS is of course welcome. It may be particularly attractive to one or more Directors of a start up company (and/or their families and friends) who wish to invest in the new company (provided the investor does not obtain more than the maximum permitted interest in the company).

The cumulative SEIS investment limit of £150,000 per company could prove to be something of a barrier to third party investors such as "business angels" however. In particular, given that almost all start up companies are very high risk investments, the third party investor will wish to undertake or commission appropriate due diligence before investing. If the total cost of that due diligence amounts to a substantial fraction of the total SEIS tax relief potentially available to the investor, then the whole investment may cease to be viable for the investor.

Hopefully, therefore, the Government may be persuaded to increase the cumulative per company limit significantly, perhaps to £500,000 or £1 million. If the cumulative limit is raised significantly, then:

the total cost of due diligence should become less of a barrier and
several investors investing together could each bear a faction of the costs

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

UK: New Seed Enterprise Investment Scheme