Every startup and growing business needs capital to develop. Over the past two decades, the UK has developed a unique ecosystem to make it easier for emerging businesses to access that essential “seed” capital. An important part of that action has been the implementation of generous tax incentive schemes to encourage individuals to invest in early-stage British companies.
Investing in early-stage businesses can offer large rewards, but comes with an associated high level of risk that can put off even the most sophisticated investors. These tax schemes were therefore designed to boost the return potential of early-stage investments and provide downside protection in case of a loss.
These tax incentives have been a resounding success, with more than 40,000 companies benefiting from them and receiving £2bn worth of investment under the schemes every year since 2014/2015 (Enterprise Investment Scheme Seed Enterprise Investment Scheme and Social Investment Tax Relief, May 2020).
So, what are these schemes, how do they work and what makes them so attractive – this is what we will try to illustrate in this article!
The first scheme to be launched was the Enterprise Investment Scheme (EIS). The UK government introduced it in 1994 to boost investments in private companies by offering generous income and capital gain tax reliefs to private individual investors.
Over 30,000 companies received funding under EIS amounting to a total of £22 billion, according to HMRC’s latest progress report from May 2020. The popularity of the scheme is still very high and, in 2018/2019, a total of £504 million of investment was raised by the 1,470 companies raising funds under EIS for the first time.
Following the success of EIS, the government decided in 2012 to go one step further to help the youngest (and riskiest) companies to also receive investment. A new scheme called the Seed Enterprise Investment Scheme (SEIS) was introduced. SEIS is essentially the little brother of EIS – it works in a similar way, but focuses on the youngest companies and provides even more generous tax reliefs to investors.
SEIS has also proven to be a success: since 2012, 12,040 young companies have received a total of £1,174 million under SEIS (May 2020 Report). The scheme has been a key driver of the entrepreneurial boom that we are currently witnessing in the UK, as it allows entrepreneurs to accelerate the first stages of building their companies.
In order to qualify for the SEIS and EIS investment schemes, a business has to be UK-registered and operate a “qualifying trade” (some trades such as property development and legal or financial services might not qualify, check out the list of exclusions here).
Businesses also have to show that they are young, small-to-medium size companies – they need to have less than 250 employees and less than £15m of gross assets to qualify for EIS. Requirements are stricter for SEIS, which was designed specifically for startup companies: businesses need to have been trading for less than 2 years, have less than 25 employees and have less than £200k of gross assets. SEIS-qualifying businesses will typically be at their early stages, sometimes pre-revenue, and therefore quite risky for investors. Companies can raise up to £150,000 under SEIS only, whereas the cap on EIS is at £5m per year (with a maximum of £12m).
Businesses can apply to HRMC for pre-clearance and receive an “advance assurance” letter, which confirms their SEIS/EIS eligibility – but does not guarantee it. Entrepreneurs must always make sure that they still meet all the criteria before accepting any investment and should work with competent accountants who can help them navigate the rules, as HRMC will take a deeper look into the business and the investment when the company requests the SEIS and EIS certificates on behalf of its investors. This tax benefit is only available for an issue of ordinary shares, which does not give investors any preferential rights.
These are the main tax benefits for investors.
Income Tax Relief
The main attraction of these schemes is the income tax relief that investors receive on their investment: under EIS, qualifying investors receive 30% of their investment back from HMRC against their income tax bill. Every year, they can invest up to £1,000,000 under the scheme and receive up to £300,000 back from the taxman.
The relief is even higher in the case of SEIS – HMRC will pay back 50% of the investment against the income tax paid up to a maximum investment of £100,000 per year.
Capital Gain Tax Exemption
The second attraction is that investors will not pay any capital gain tax on disposal of their SEIS or EIS investments, provided they have held the shares for at least three years.
In case the investment fails and the company is liquidated, investors are eligible for a loss relief of up to 22.5% or 31.5% of their initial investment for SEIS and EIS respectively.
This means that between the Income Tax and Loss reliefs, high-rate tax-paying investors only risk to lose 27.5% of their investment under SEIS and 38.5% under EIS. This is a huge downside protection provided by HMRC.
SEIS and EIS also offer a range of additional tax benefits that can be attractive depending on the investor’s situation, such as a CGT Reinvestment Tax Relief, CGT Tax Deferral and Inheritance Tax Relief.
Receiving the Tax Benefits
In order for investors to claim these tax benefits, the company that received their investment will need to contact HMRC and provide its investors with a certificate allowing them to claim the reliefs themselves directly via their Self-Assessment Return. Investors should be aware that this process can take up to 6 months after their investment.
It is important to mention that the tax benefits depend on personal circumstances and are subject to changes, and so all investors are always advised to seek professional advice!
Capital at risk. For professional investors only.
Last edit: 18th February 2021