Tax Relief for Dragons attracts new investors

Most of us will have seen the investors on Dragons’ Den parting with their cash in exchange for a stake in whatever business they sense has the required potential for growth.  It may be that the Dragons will seek to claim various tax reliefs available on their investment under the Enterprise Investment Scheme (EIS) which aims to provide tax efficient ways for investors to invest into privately owned trading companies.  EIS was introduced by the Government to assist small higher risk trading companies to attract investment and offers investors both income tax relief and capital gains tax (CGT) relief on their investments.

Set out below is an overview of the tax reliefs available.

Income tax relief available

Investors can secure 30% income tax relief as illustrated by the following example. Mr A buys £100,000 of shares in a trading company owned by a friend, giving him a 20% stake.  During the 2015/16 tax year, Mr A receives £150,000 income from his existing company.  He receives income tax relief as follows:

Let’s assume that, without EIS income tax relief, his income tax liabilities would be £45,000.

Mr A receives £30,000 of income tax relief resulting from his investment (30% x £100,000) reducing his 2015/16 income tax liabilities to £15,000.

This reduces the effective cost of his investment by £30,000 to £70,000.

Capital Gains Tax deferral relief

CGT payable on profits arising from the sale of other assets can be deferred if investments are made into companies qualifying for EIS relief as illustrated by the following example.

One year after the EIS investment, Mr A sells an investment property and realises a gain of £50,000 on which CGT of £14,000 would be otherwise be payable.

Because Mr A has invested the proceeds from the sale of the property into a qualifying EIS investment during either the 12 months before or the 3 years after the sale, he can postpone the payment of the CGT liability of £14,000 until he sells the shares in the trading company.

Selling the shares in the trading company

What happens when Mr A decides to realise his investment in the trading company?

In May 2020, Mr A accepts an offer of £250,000 for his 20% shareholding in the trading company

• Because the EIS shares have been held for more than 3 years, no CGT is payable on the £150,000 profit arising on the disposal of the shares in the trading company.
• There is no claw-back of the £30,000 of income tax relief claimed on the initial investment.
• However, Mr A will now need to pay over the £14,000 of CGT postponed from the earlier sale of the investment property.

Mr A can postpone again the £14,000 should he make further investments qualifying for EIS. EIS is very useful at allowing investors to make and realise profits on a series of EIS investments without paying any CGT until EIS shares are sold without a subsequent qualifying re-investment.

Qualifying conditions

There are a huge number of eligibility criteria which apply to the investor and the investee company which have not been covered here in great detail. Suffice it to say that professional advice should be sought to ensure that the proposed investment will qualify under EIS rules. However, summarised below are some of the key conditions to be met

The investor cannot normally own more than 30% of the company being invested in.

Investments into companies owned by close relatives will probably not qualify for relief.

Income tax and CGT relief normally rely on the investment being held for a minimum of 3 years.

Companies with Gross Assets (property, plant, cash, debtors) of up to £16m can qualify so fairly sizeable companies will qualify.

The company needs to spend the cash investment received for the purposes of its trade.

The investor cannot normally have an existing shareholding in the company.

Seed Enterprise Investment Scheme (SEIS)

SEIS gives similar tax reliefs to EIS but gives 50% income tax relief on up to £100,000 of investments into qualifying smaller companies.

Summary

EIS and SEIS offer very significant tax reliefs to investors and business angels seeking to invest private capital into smaller trading businesses. Any budding Dragons should definitely have an understanding of how they may be able to benefit. We are able to advise fully on all aspects of EIS and SEIS so please get in touch if advice is required.