The conditions listed below must be met by a company to qualify for investment under EIS, both at the time of the investment and throughout the three-year minimum holding period. Otherwise, the company will not be qualifying, and investors will lose and/or face clawback of the tax reliefs given:

• The first commercial sale occurred within the last seven years, or the last ten years for a Knowledge Intensive Company (KIC).
• Have fewer than 250 full-time employees or fewer than 500 for KICs.
• Carry out a qualifying trade.
• Gross assets are less than £15 million before the investment and £16 million following the investment.
• The company cannot be controlled by another company, meaning that another company should not own more than 49% of the company’s shares.
• Not listed on a recognised stock exchange, excluding the Alternative Investment Market.
• A permanent establishment in the UK.
• Raise less than £5 million a year, with a maximum investment of £12 million over the company’s life.
• The funds must be spent within two years of the investment.
• Be able to demonstrate growth and development in the future.
• Shares will be full-risk ordinary shares with no preferential arrangements in place.
• There must be no capital preservation provisions, such as joint venture partnerships, in place.

To qualify for EIS, a company’s first commercial trading date must be within the last seven years, or ten years for knowledge-intensive companies. Companies can use either the date of commencement of trade when revenue was generated or when the business began marketing its product or service.

In the EIS application, HMRC will ask for both the date of incorporation and the company's first commercial trading date, if applicable. If the company has not yet begun trading, state this in the application and indicate that the investment raised will be used for preparation to trade. If HMRC has any reason to doubt the dates the company began trading, it will look for information both in the documents provided and what is available online.

Companies whose first commercial sale occurred more than seven years (or ten years for KIC) ago will not qualify for EIS unless they can meet at least one of the three conditions. HMRC will not accept any other circumstances than those listed:

• If a company received risk finance investment within seven years (or ten years for KIC) after the date of the first commercial sale, and the funds to be raised after the seven years are for the same trade.
• A company may qualify if it has at least 50% of its average turnover from the last five years of trade, and the investment is being used to enter a new product market or a new geographic location.
• If the company meets condition two, and the money raised is for the same trade.

Companies should be aware that these applications are more complex than those done within the first seven years of the company's date of first commercial sale.

Before the company issues shares, it must have fewer than 250 (or 500 for KIC) full-time employees to qualify for EIS. HMRC will confirm the number of full-time employees the company has at the time of investment, reviewing its PAYE payroll scheme to determine this.

The company should include the number of employees in their cover letter as part of their application, and whether they plan to hire additional employees following the investment. Be aware that directors, subcontractors, and consultants are not employees, so don't include them in employee numbers.

Companies must either exist to carry out a qualifying trade or be the parent company of a trading group that conducts qualifying trades. There must be no arrangements for the company to become a subsidiary of, or be controlled by, another company.

A trading group is a group that, directly or indirectly, owns more than 50% of the shares of each subsidiary held as a member of the group. Still, any subsidiary employing any of the money raised by the issue of shares must be a qualifying 90% owned subsidiary. Non-qualifying trading activities must not be a substantial part of the group's overall trade. HMRC classified substantial as 20% of the overall trade. Companies will have to demonstrate how their non-qualifying trade is not substantial in their application. Companies should determine whether they can stay below the 20% mark, as they will need to maintain this until after the three-year minimum holding period.

Most trades are qualifying trades for EIS purposes, but the following are excluded:

• Dealing in land, commodities, futures, shares, securities or other financial instruments;
• Dealing in goods other than in the course of an ordinary trade of wholesale or retail distribution;
• Banking, insurance, money-lending, debt-factoring, hire-purchase financing or other financial activities;
• Leasing (including letting ships on charter or other assets on hire);
• Receiving royalties or licence fees (subject to the exception relating to self-generated intellectual property);
• Providing legal or accountancy services;
• Farming and market gardening;
• Holding, managing or occupying woodlands, any other forestry activities or timber production;
• Property development;
• shipbuilding;
• producing coal and/or steel;
• Operating or managing hotels or comparable establishments or managing property used as a hotel or comparable establishment;
• Operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home;
• Generation or export of electricity or power, both renewable and non-renewable;
• Production of gas or fuel; and
• Providing services to another person where that person's trade consists, to a substantial extent, of excluded activities, and the person controlling that trade also controls the company providing the services.

Before EIS, gross assets must be less than £15 million and less than £16 million after shares are issued to qualify. The investment received under EIS is not included in the gross assets test performed by HMRC; gross assets include fixed tangible assets, current assets and intangible assets. A company's gross assets will be demonstrated in the financials that the company provides with its application.

HMRC requires companies applying for EIS to be independent; another company must not control the company. HMRC will assess control in terms of ownership and if the potential controller is a creditor of the company.

There must be no plans for companies applying for EIS to be quoted on a recognised stock exchange. The Alternative Investment Market (AIM) is not a recognised stock exchange under EIS; a company can be quoted on the AIM and qualify for EIS investment.

Companies applying for EIS must have a trade location in the UK, where a significant portion of their business is conducted. A company incorporated in the UK automatically meet this condition. However, non-UK companies must meet this condition in an alternative manner. Under EIS, this means a company must either have a permanent location (branch/management location) or a UK qualifying agent (residing in the UK).

EIS qualifying companies cannot raise more than £5 million (£10 million for KIC) in a year with risk finance investment and State Aid. State Aid rules restrict companies from raising up to £5 million through EIS, SEIS, SITR, and VCT investment (referred to as “risk finance investment”) in one year. Also included within this limit are any other funds received that are considered EU State Aid. A maximum £12 million (£20 million for KIC) can be raised under EIS in the company’s lifetime, this includes money raised under Venture Capital Trusts, Seed Enterprise Investment Scheme, Social Investment Tax Reliefs and State Aid promoting risk finance investment. The investment companies raised under EIS cannot be used to buy all or part of another business; they must be used to grow or develop the business.

EIS shares must be paid in full and in cash into the company's bank account when issued. When submitting the company's EIS application, the company should also submit a copy of their bank statement, demonstrating to HMRC that the shares were paid in full before they were issued. EIS qualifying shares must be full-risk ordinary shares with no preferential or redemption rights or carry no special rights to your assets. The shares issued can have limited preferential rights to dividends, but these rights cannot be accumulated or varied to alter the dividend amount.

There must be no arrangement in place for preserving share capital or pre-arranged exits for investors to recover their investment. HMRC will not accept any reciprocal arrangements in place where two company founders agree to purchase shares from each other’s business to benefit from EIS tax reliefs.

The Risk to Capital condition, introduced by HMRC in 2018, has two parts:

1. Growth and Development: The company must have the objective of long-term growth and development.
2. Significant Risk: There is a considerable risk that investors may lose their investment.

The Risk-to-Capital condition ensures that companies undertake the appropriate growth and risk that Venture Capital Schemes were created to support. Some factors to consider regarding this condition include the number of employees, company assets and the industry. A company should perform a SWOT analysis to assess its strengths, weaknesses, opportunities, and threats, providing a clear view of its risks to capital, as well as its obligations to HMRC.

Financial difficulty occurs when a company is unable to meet its debts as they become due or when the liabilities of a company exceed its assets. HMRC will consider a company to be in financial difficulty if:

• The company cannot pay their debts as and when they fall due.
• The value of the company’s liabilities exceeds its assets, considering both its contingent and prospective liabilities (the “balance sheet test”).
• The company has been in trading for more than seven years, and over half of its subscribed share capital has been wiped out due to accumulated losses. It is regarded as being in financial difficulty.

Companies should not mislead HMRC regarding their financial situation; otherwise, this may result in investors being unable to obtain the tax reliefs offered by the Scheme.

EIS reliefs cannot be used as a tax mitigation or avoidance product; companies under EIS must have a commercial purpose and not be set up solely for the benefits of tax-advantaged finance. Following the issuance of shares, there cannot be:

• Any protection for the investment or protection for the investor from risk.
• The intent to sell the shares after, or through, the investment period.
• Activities that allow an investor to benefit in a manner that the scheme does not intend.
• A reciprocal agreement where the companies invest back in an investor’s company to also gain tax relief.

Any company or agent making an application for EIS advance assurance must reassure HMRC that the application is not speculative. The company has potential investors, implying that it will secure investment if it obtains advance assurance. Companies should provide a list of at least six names and addresses of potential investors or provide a letter of intent from a fund or crowdfunding platform to avoid speculative applications.

To be classed as a KIC, companies need to meet the IP condition or the Skilled-Employee condition.

• IP condition: The company must develop a product or service that generates intellectual property and will be implemented in the business's trade within the next ten years.
• Skilled-Employee condition: At least 20% of a company’s employees must have a relevant master’s or higher degree and be conducting research for more than three years from the date of investment.

Once a company meets either of the two above conditions, it must then meet the following conditions to qualify for EIS as a Knowledge Intensive Company.

• The company must have fewer than 500 full-time employees at the time the shares are issued.
• Research and development, or innovation, must account for 10% of a company's overall operating costs for three consecutive years or 15% in one of the three years preceding the investment. If the company is less than three years old, the accounts must include a schedule demonstrating this.
• Knowledge-intensive companies can qualify for EIS if they’re within ten years of either their annual turnover exceeding £200,000 or the date of their first commercial sale.
• If a company obtained investment during this period (authorised under the risk finance guidelines), it could raise money for the same activity, provided it demonstrates its intent in the business plan.

As an EIS Knowledge Intensive Company, a company can raise a maximum of £10 million per year and a maximum of £20 million of investment in the company's lifetime. For Knowledge-Intensive Companies, the age limit is ten years, and a company can choose to use the date from the end of the accounting date when their turnover reaches £200,000 per year, instead of the company’s incorporation date.

Investors must meet the following conditions to qualify as an EIS investor:

• Investors must be UK taxpayers.
• Investors can invest a maximum of £1 million (or £2 million for KIC) in EIS investments per tax year.
• EIS shares must be held for a minimum holding period of three years from the time of investment. Investors who divest before the three-year period will face clawback of tax reliefs.
• Investors cannot have a connection to the company, such as being an employee, family member, or paid director.
• Investors cannot hold more than 30% of the company’s share capital to qualify for EIS.
• Investors cannot qualify as EIS investors if they have previously invested in the company.

The conditions listed above must be met to qualify for investment under EIS at the time of the investment and throughout the three-year minimum holding period. If investors fail to maintain these conditions, they will no longer qualify and may lose and/or face clawback of the tax reliefs granted. Should an investor become ineligible at any point, they should inform HMRC as soon as possible.

Each application for EIS typically takes a maximum of eight weeks to approve; however, they generally are returned much quicker than this. However, this can depend on whether HMRC has any questions about the application. HMRC may have questions seeking further clarification on whether a company meets one or more of the qualifying conditions, which can delay the grant of EIS advance assurance. Depending on whether a company goes through advance assurance, there are four stages to the process:

Advance Assurance

Companies applying for EIS are not required to go through advance assurance. Still, it is recommended to ensure there are no surprises for a company or its investors when an investment is received. Not all companies will file for advance assurance, making a company more attractive to prospective investors. Advance assurance is essentially “pre-approval” from HMRC that the company meets the qualifying conditions. Before starting the application, a company should have the following documentation and information:

• A valid Unique Tax Reference (UTR) and a Company Reference Number (CRN).
• Latest company accounts and any accounts for any subsidiaries, if applicable.
• The business plan, including financial forecasts.
• Details on how the company will use the funds raised under EIS.
• An explanation of how the company meets the risk-to-capital condition.
• A schedule of all tax-advantaged investments received by the company, including the amount, date and scheme under which each investment was received.
• An up-to-date copy of the Memorandum and Articles of Association, with a detailed explanation of any changes to be made.
• Details of any shareholder agreement or any other subscription agreement the company intends to establish.
• The latest draft of any prospectus, information memorandum, brochure or similar document relating to the relevant fundraising or offer to be issued to potential investors, if applicable.
• Information on any financial support received by the company that constitutes EU State Aid.

Once a company has all the above documentation, it can then begin filing for the advance assurance with HMRC. Once this has been filed, HMRC may follow up with questions regarding the details in the application to ensure that all conditions are met and no disqualifying activities are occurring. If successful, HMRC will subsequently grant the company provisional acceptance of its eligibility for EIS. Companies can then use this provisional acceptance to approach prospective investors and encourage them to invest.

EIS1

Companies that apply for advance assurance will have a quicker and simpler application process when submitting their EIS1. This is due to having already provided the necessary documentation needed by HMRC, and will therefore only need to provide documentation for any changes in the business and the issuance of shares. However, if a company has not sought advance assurance before issuing shares, it will need to provide more information for its EIS1 compliance statement.

• A valid Unique Tax Reference (UTR) and a Company Reference Number (CRN).
• Latest company accounts and any accounts for any subsidiaries.
• The business plan, including financial forecasts.
• Details on how the company will use the funds raised under EIS.
• An explanation of how you meet the risk to capital condition
• A schedule of all tax-advantaged investments received by the company, including the amount, date and scheme under which each investment was received.
• An up-to-date copy of the Memorandum and Articles of Association, with a detailed explanation of any changes to be made.
• Details of any shareholder agreement or any other subscription agreement the company intends to establish.
• The latest draft of any prospectus, information memorandum, brochure or similar document relating to the relevant fundraising or offer to be issued to potential investors.
• Information on any financial support received by the company that constitutes EU State Aid.
• A bank statement showing that the shares have been paid in full.

The EIS1 form must be submitted every time the company issues EIS shares and should be submitted within two years of the shares being issued; otherwise, investors will not be eligible for their tax reliefs.

EIS2

When HMRC approves the application, the company will receive an EIS2, which is essentially confirmation from HMRC. This lets companies know that the shares they issued have been authorised, and EIS3 forms can be issued to the investors recorded in the EIS1 application.

The company must have spent at least 70% of the funds or traded them for at least four months to submit this application. HMRC constitute the trading element as making or trying to make a sale. 

EIS3

Once a company receives confirmation from HMRC in the form of an EIS2, it can then issue EIS3s. The company uses the information from the EIS2 document to complete the EIS3 form, including the Unique Investment Reference (UIR) and the termination date for the shares. The EIS3 form must be authorised by both a company representative and the investor before being submitted to HMRC.

Following the completion of the EIS process, it is up to the EIS qualifying company and its investors to stay qualifying throughout the three-year holding period. Furthermore, if the company raises additional investment through EIS, it will have to do the EIS1/EIS2/EIS3 process for each round of funding.

Additional Information

If the company is less than three years old, it should consider the Seed Enterprise Investment Scheme (SEIS), which encourages investors to make investments in companies at the start of their trading. Under SEIS, qualified UK investors will benefit from:

• 50% Tax Relief
• 100% Capital Gains Tax relief
• 50% Capital Gains Tax exemption for chargeable gains reinvested
•  
• 100% Inheritance Tax relief (within the £1M allowance from 6 April 2026)
• Loss Relief

For more information on the Seed Enterprise Investment Scheme (SEIS),  please visit Sapphire's SEIS Pillar Page, Learning Centre, or MoneyLab Blog. Furthermore, a company can raise capital through investment in a fund. Given the high likelihood of an early-stage company's failure, a fund allows the investor to achieve greater diversification within their portfolio. 

Disclaimer

Please note that this is a condensed summary of the taxation legislation and should not be construed as constituting advice that a potential investor should obtain from their own investment or taxation adviser. The value of any tax relief will depend on the individual circumstances of investors.

Sapphire Capital Partners LLP does not give tax advice and recommends that you consult a tax adviser if you are in any doubt about any of the technical aspects of the EIS legislation.