SEIS and EIS facilitate private investment into companies by providing investors generous taxincentives, such as income tax relief, capital gains tax deferral, inheritance tax relief and loss relief. A great summary of investor incentives can be found on the infographic that we created for a prior blog: SEIS versus EIS - a visual comparison.
One of the requirements for companies to qualify for SEIS and/or EIS, is that they must continue trading for at least three years from the time the SEIS/EIS shares are issued. This requirement reinforces government’s commitment to support entrepreneurship and permanent job creation within the UK. Government wishes to support medium to long term company trade, and we have seen a tightening of the rules around the schemes to ensure that they serve this purpose.
But what happens if a company has every intention to continue trading for over three years at the date of SEIS / EIS share issuance, but due to unforeseen events exits prior to the three year holding period? What repercussions are there for breaking the SEIS / EIS rules?
To answer this, we must look into the reasons for the aforesaid company’s quicker-than-anticipated exit.
For example, if a company goes into liquidation, with an administrator formally appointed, then HMRC would most likely not request the tax incentives back from investors. That means that income tax relief and any capital gains tax deferral relief already claimed wouldn’t have to be returned to HMRC. Furthermore, investors would also be eligible to claim loss relief, where the capital loss will be allowable to be claimed; note however that any income tax relief obtained will reduce the allowable capital loss.
If however a company exits prior to the three-year holding period via a commercial transaction such as a third party sale, a management buy-out, or an exchange listing, then investors will be required to return any tax incentives already claimed to HMRC. Investors may still be eligible to claim loss relief. However, loss relief triggers in the event of a loss, so the question as to why the company seeks to exit at a loss prior to the three-year period needs to be addressed.
As independence rules prevent EIS investors from also being employees in the business, and also severely limit SEIS investors’ involvement in the business, one cannot help but wonder… “is this fair”? Are investors taking up the risk for a return that may be clawed back from them due to an event beyond their control?
This is where the principle of “caveat emptor” needs to be heeded. As an SEIS / EIS investor, when agreeing the shares and equity stake hold, voting rights should be looked into. It may be best for the shares to carry voting rights to ensure the investor has a voice when it comes to major corporate decisions like exits and liquidations.
Investors need to understand a company’s business plan, what the company intends to do and when an exit is expected to occur, or what sort of event would trigger it. Due diligence and careful scrutiny of the management team should be made to ensure that the team means what they say. At the end of the day, it ultimately comes down to whether investors and management trust each other.
