Changes to EIS rules

Changes to EIS rules

The Enterprise Investment Scheme (EIS) allows investors to take advantage of a tax break by investing in a variety of schemes – it was introduced to encourage individuals to invest in small, higher-risk trading companies. However, over the years, many of these investments have moved towards lower risk asset-backed (mainly property) projects, such as pub chains, self-storage and crematorium.

The introduction of the Finance Act 2018 (which received Royal Assent on 15 March 2018) has now put paid to such “low risk” investments. The Government has stated that its intention is that EIS is to be used for higher growth, higher risk companies, in particular ‘knowledge intensive’ companies which focus on innovation, research and development.

Consequently, for EIS, SEIS and VCT investments, the Finance Act 2018 has established a new ‘risk to capital’ condition which is unlikely to be satisfied by those “low risk”, asset-backed investments that looked to preserve capital rather than fund significant growth. The condition introduced in section 157A Income Tax Act 2007 introduces principles-based tests to determine if, at the time of investment, a company is a genuine entrepreneurial company with an objective to grow and develop, and whether there is significant risk to loss of capital (that is potentially greater than the net return). The condition requires all relevant factors about the investment to be considered in the round. This suggests that some degree of certainty must be known at the point of investment and either already arranged or be in discussion. Further clarification on this will however be provided in final guidance, which is due to be published in April 2018.

Furthermore, HMRC previously stated that, with effect from 1 December 2017, it would not issue advance assurances to those companies that would more than likely fail the new capital risk condition. In addition, even where the risk to capital condition would be satisfied, HMRC will only provide advance assurance where the application names those who will be making investment. This could cause issues for schemes (such as EIS) where in some cases it has not been possible to know in advance who the investors will be. However, better formulation of a business plan, as well as more preparation into approaching potential investors before the opening of an investment scheme could see HRMC providing the required advance assurance.

However, for every piece of bad news there is some good news. Under the new rules, the amount of capital that can be invested by an individual has risen from £1 million to £2 million, provided that £1 million of this will be invested into ‘knowledge intensive’ companies. Additionally, the total amount that can be raised annually for ‘knowledge intensive’ companies has risen from £5 million to £10 million. This means that the potential returns – and following on from that, the potential tax savings – will be much greater and beneficial to an investor than previous schemes have allowed.