Investors lose EIS tax relief
WN writes: My company has just raised £350,000 to start trading. It took some time to satisfy the interests of the various investors. The result is that we have different classes of shares — each with different rights to income and voting. At the outset, we had indicated that investors might be able to get relief under the Enterprise Investment Scheme (EIS), and now one investor is complaining that he cannot. The company trade has not changed, so what is the problem?
The benefits of the EIS are significant, but they come at the expense of a number of rules, writes Jon Sutcliffe, partner at Kingston Smith LLP. The benefits are: 30% income tax relief on the investment; capital gains exemption; and deferral of capital gains where the proceeds are reinvested under the EIS. The scheme is designed to encourage investment in ordinary shares, which are defined by HM Revenue & Customs (HMRC) as shares that carry full equity risks in a business.
Your problem is likely to be that the different rights attached to each share mean that the EIS rules do not consider some of the shares to be ordinary shares. There is no specific problem with shares having preferential voting rights. The issue is the different rights to income and capital on each class of share. HMRC rules do not allow EIS shares to have any preferential right to dividends, or to a company’s assets on its winding up.
Where share rights differ, it may be that some share classes will qualify for EIS and others won’t.
Investments that qualify for EIS at the outset always risk losing their status at a later date, through no fault of the investor. This can happen when a company changes its capital structure. When this happens within the three-year period after investment, the benefits enjoyed under EIS are clawed back.