I’m loving angels instead... Tax breaks for investors in business startups

BERNARD CRITCHLEY TAX MANAGER, ASPEN WAITE

I’m loving angels instead... Tax Breaks for investors in business startups.

As we move back towards normality, several early-stage companies may be looking to outside investors to inject finance into their company to assist in its growth, such as hiring new employees, developing a product or marketing.

By subscribing for new shares an individual investor could benefit from generous income tax and capital gains tax reliefs, under the Enterprise Investment Scheme (EIS) if the company has been running for less than seven years or Seed Enterprise Investment Scheme (SEIS) if the company is newly established - provided their individual shareholding (added together with those of their associates such as business partners, trustees, spouses, children and parents) does not exceed 30% of the total shares in the company.

Most new unquoted companies’ trades would qualify unless they were providing legal and accounting services, banking or were involved in property development or dealing in land. Companies can raise up to £5 million each year up to a maximum of £12 million in the company’s lifetime. Furthermore, each company can apply for Advanced Assurance from HMRC that the shares would qualify for relief before the shares are issued.

If the company is older than the normal scheme allows, it may still qualify for the benefit of EIS investment if it meets the conditions for relief and it could be catagorised as a knowledge intensive company. Such companies would be less than ten years old and either conducting work to create intellectual property (and expect most of the business to come from this within ten years) or have 20% of the employees conducting research for at least three years from the date of investment.

The Chancellor of the Exchequer has indicated that these schemes will run until 5 April 2025 but there is still time for both companies and individuals to act to benefit from the advantages that the scheme currently offer both for the companies and their prospective investors.

From the individual’s point of view the two schemes are similar but have some crucial differences.

SEIS is focused on very early-stage unquoted companies and allows an individual to invest up to £100,000 per tax year and get a 50% tax break in return. The investor would also benefit from exemption to capital gains tax on the sale of the shares after three years.

EIS, on the other hand, focuses on medium sized startups. It allows an individual to invest up to £1 million per tax year and to receive a 30% tax break in return. As with SEIS, the individual investor will not pay capital gains tax on any profit arising from the sale of shares after three years.

For both SEIS and EIS any unused relief in a given tax year can be carried back to the previous tax year but cannot be carried forward so some unused relief may be lost.

Additionally, should the company fail, or the shares are subsequently sold at a loss, the investor can choose whether to offset the resulting loss against their capital gains in the year or claim the loss against their general income and obtain an income tax refund, whichever is more beneficial.

One further benefit of holding the SEIS or EIS shares is that there is no Inheritance Tax to pay on shares held for at least two years as they would qualify for 100% Business Property Relief.

Example

George (who is not an employee of the company) decided to invest £100,000 in March 2021 in a recently established unquoted company which qualified for EIS relief. His income tax relief is therefore £30,000.

On completion of the 2020/21 Self-Assessment Tax Return George’s tax liability is calculated at £20,000 of which £18,000 has been deducted under PAYE through the monthly payroll.

George’s relief is, therefore, restricted to £20,000, with £18,000 being refunded and the balance used against the further tax that would otherwise be payable for 2020/21 following submission of the Tax Return. Assuming that George’s tax position is similar for 2019/20 the balance of the relief of £10,000 can be claimed in that year from the tax deducted under PAYE.

The company trades successfully and in June 2024, George’s shares are now worth £150,000. George, who has no children of his own, decides that he wants to help his sister, Emily and her two children and wonders if he should sell some or all the shares and give her the money directly. The uplift in value would not give rise to a capital gains tax liability but the gift of the cash to Emily would continue to form part of his estate for the next seven years and may increase any Inheritance Tax should he pass away in the meantime.

An alternative strategy could be to either give Emily some or all the shares directly or put the shares into a trust for Emily and her children so that the shares could be sold when the cash is needed. In either case the shares would no longer qualify for exemption from capital gains tax so any further growth may be taxed, but George’s gift would qualify for Inheritance Tax Business Property Relief, meaning it is completely tax free from his perspective. Furthermore, once the shares are held for two years from George’s gift, they would then qualify again for 100% Business Property Relief for the new owner, provided the company remains unquoted and continues to trade.

Whilst EIS and SEIS may not be attractive to all investors, because of the risk associated with the investment, there would still be a considerable number of individuals who may be comfortable with weighing up the risk of the investment with the associated rewards of ownership of fledgling businesses and the tax breaks that may result.

Although the relief is scheduled to end on 5 April 2025, it can only be hoped that the EIS and SEIS schemes are continued beyond that point or are replaced with equally attractive alternatives.