UK: Enterprise Investment Schemes - Determining Qualification For Income Tax Relief

Last Updated: 9 April 2001
Article by Adam Fenner

Qualifying individuals can receive Income Tax relief at the lower band, currently 20%, on their total investment into a qualifying company, up to a limit of Ł150,000 per tax year. The EIS scheme has proved popular with both business angel investors and the target investee companies, acting as an effective incentive to bolster the lower end of the equity investment market. Investors need to be vigilant, however, in ensuring that they qualify for the valuable income tax relief in advance of any potential investment as the inevitable urgency surrounding fund raisings may leave little scope for last minute EIS issues to be considered close to completion of the investment.

1. Qualifying Individuals – Working Relationship

An individual will qualify for relief if: (i) he subscribes for the shares in the issuing company on his own behalf and (ii) he is not connected with the issuing company. An individual will be connected and therefore ineligible for Income Tax relief under the EIS rules in one of two ways. Firstly, by virtue of a working relationship with the Company, if the individual:

  • is an employee or partner of the issuing company (or its subsidiary); or
  • is a partner in any business partnership of which the company or any subsidiary is a member, or an employee (other than a director who is an employee) of such a partner; or
  • is a director of the company or any subsidiary, or a director of a partner in any business partnership of which the company or any subsidiary is a member; and
  • he receives, or is entitled to receive, or any associate receives, or is entitled to receive, any kind of payment from the company (or any related person), apart from:
  • payments for expenses incurred in the performance of duties as a director which do not give rise to a tax charge in the hands of the director;
  • fees for providing certain services to the company (or a related person), in the course of a business but not secretarial or managerial services or services of a kind provided by the person to whom they are rendered;
  • certain other kinds of payment (provided they are not in excess of a normal commercial rate). Broadly, these are dividends or other distributions, rent for property occupied by the company (or any related person), interest on money lent to, or on behalf of, the company (or any related person), and payments for the supply of goods.

For the purposes of this connection rule:

  • persons related to the company include any company of which an individual or any associate is a director and which is a subsidiary or a partner of any business partnership of which the company or any subsidiary is a member (person here means any legal person, not just an individual); and
  • the expression director includes anyone acting as a director and anyone concerned with the management of the company's business who controls 20 per cent or more of the company's ordinary share capital.

Exceptions For Business Angels

There are special rules which apply if an investor wants to become a paid director of a company in which they invest, whether in an executive or a non-executive capacity. Such investors may be referred to as Business Angels.

To qualify for income tax relief, they have to satisfy all the normal conditions except that they may become a director of the company (or a subsidiary), and receive payment for services provided to it despite the fact that they would thereby become connected with the company for EIS purposes.

Certain additional requirements must be satisfied:-

  • They must be issued with the shares on which the relief is to be claimed before the start of any period for which they are entitled to receive payment.
  • They must never previously have been connected with the company in any way for EIS purposes, and must not become connected with it in any way other than as described above.
  • In addition, they must never have been involved in carrying on (as a partner, director, or employee) the whole or any part of the trade or business carried on by the company or any of its subsidiaries.

Subject to the usual annual investment limits, and if they do not become connected with the company for EIS purposes in any way other than by being a Business Angel (or because an 'associate' is such a Business Angel), they can claim relief for further qualifying investments in the company. They must be made within the five years beginning with the latest date on which eligible shares were issued before they became connected with the company for EIS purposes as a paid director.

An individual can become a Business Angel investor only if they are not, and never have been:

  • a paid director of the company or any of its subsidiaries (or a paid director of a partner of the company or any of its subsidiaries), or
  • connected with the company in any other way for EIS purposes.

2. Qualifying Investors – Control / 30% Rule

An individual will also be connected and therefore ineligible for Income Tax relief for EIS purposes by virtue of owning a stake in the company, if at any time, alone or together with 'associates', he:

  • controls the company or any subsidiary; or
  • directly or indirectly possesses, or is entitled to acquire, more than 30 per cent of:
  • the issued ordinary share capital of the company or any subsidiary
  • the loan capital and issued share capital of the company or any subsidiary
  • the voting power in the company or any subsidiary, or
  • the assets of the company or any subsidiary on a winding-up.

However if an individual holds, or an associate holds, any shares in the company when it has not issued any shares other than subscriber shares, and has not begun to carry on, or to make preparations for carrying on, any trade or business that fact will not cause the individual to be connected with the company for EIS purposes.

"Associates" for EIS purposes are:

  • parents, grandparents, great-grandparents etc.;
  • spouses;
  • children, grandchildren, great-grandchildren etc.;
  • the partners in any business partnership of which an individual is a member; and
  • the trustees of any family trusts (and certain other trusts) in which an individual has an interest.

Capital Gains Tax deferral relief is available even for an individual who is connected to the company in which they are investing. An individual can qualify for deferral relief on making a qualifying investment even if they wholly own the company in which they invest.

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.

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