SEIS and EIS Funds

Funds. A Summary of SEIS and EIS funds.

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SEIS and EIS Funds
Funds: the Seed Enterprise Investment Scheme and Enterprise Investment Scheme.

 
Fund Structures

A fund is typically an investment management service conducted on a discretionary basis by an investment manager (such as Sapphire) acting as a common discretionary investment manager. This service will normally be conducted subject to the terms of the investment management agreement. By agreeing to invest in a fund, investors appoint the investment manager to invest their subscriptions on a discretionary basis into companies selected by the investment manager. A SEIS/EIS fund is normally not a legal entity, nor is it considered to be a collective investment scheme as defined in section 235 of the Financial Services and Markets Act 2000, but it is considered to be an Alternative Investment Fund ("AIF") for the purposes of the Alternative Investment Fund Managers Directive ("AIFMD").

Life of the Fund

In order to retain the SEIS and EIS Reliefs, investors must hold the qualifying shares for the SEIS and EIS three year period. Normally the investment manager will consider options for realising the qualifying shares in the interests of the investors after the expiry of the SEIS and EIS three year period. The investment manager normally has absolute discretion to liquidate any individual shareholdings in the fund (but such termination may result in a loss of SEIS and EIS Reliefs and crystallisation of CGT in respect of capital gains on which CGT Reinvestment Relief had been claimed).

Following realisation of the qualifying shares in each investee company, the realisation proceeds are paid to investors. Consequently, it is possible that investors will receive distributions from a fund over a period of time.

The Custodian

The investment manager normally enters into an agreement with a custodian for the custodian to provide receiving agent and custodian services to the investment manager and each investor, which will include administration, custodial and nominee services in accordance with the terms of that agreement.

The agreement with the custodian is normally terminated by either the investment manager or the custodian upon six months’ written notice to the other and may also be terminated immediately on notice for cause including in the event that a party ceases to be FCA authorised or on the insolvency of either party.

Financial Services Compensation Scheme

Both the investment manager and the custodian will normally participate in the Financial Services Compensation Scheme, established under the Financial Services and Markets Act 2000. The scheme provides compensation to eligible investors in the event of a firm being unable to meet its customer liabilities. Payments under the scheme to an eligible investor for protected claims against a firm in respect of protected investment business are limited to a maximum of £50,000. Further information is available from the Financial Services Compensation Scheme, 7th Floor Lloyds Chambers, Portsoken Street, London E1 8BN.

Alternative Investment Fund Managers Directive and Eligible Investors

The AIFMD came into full effect on 22 July 2014. The FCA have indicated that, in their view, EIS and SEIS funds fall within the definition of “Alternative Investment Fund” for the purposes of the AIFMD.

Typically the investment manager will treat the fund as its client for the purposes of determining which provisions of COBS will regulate the obligations owed by the investment manager to investors in common. Although the investment manager will, at all times, typically act in the best interests of the investors in common, they normally are not be treated on an individual basis as clients of the investment manager for regulatory purposes and will not, therefore, have the same protections under COBS as if they were treated as a client of the investment manager on an individual basis.

Recital (20) to the AIFMD provides that where an external AIFM has been appointed to manage a particular AIF, that AIFM should not be deemed to be providing the investment service of fund management as defined in point (9) of Article 4(1) of the MiFID Directive, but, rather, collective fund management in accordance with the AIFMD. In providing the discretionary investment management service the investment manager is therefore not carrying out MiFID or equivalent third country business. 

SEIS/EIS Fund Structure and Administration

A SEIS/EIS fund is typically a SEIS and EIS venture capital fund where the investment manager acts on behalf of all investors in common when making and, by negotiating investment agreements which provide minority protection rights, managing investments which fall within the common investment policy for the fund.

In accordance with current FCA policy, typically a SEIS/EIS fund is the regulatory client of the investment manager for the purposes of determining which provisions of the FCA Conduct of Business Rules will regulate the obligations owned by the fund investment manager to investors in common, and who accordingly, will not be treated, on an individual basis as clients of the investment manager for regulatory purposes. A SEIS/EIS fund will be a professional client of the investment manager. A fund is an EIS fund for the purposes of FCA regulations and is not a collective investment scheme or a non-mainstream pooled investment and is therefore not subject to the marketing restrictions introduced by the Policy Statement published by the FCA on 4 June 2013 and known as “PS13/3”.

Participation in a Fund

Typically, each investor will separately enter into an investment management agreement with the investment manager, pursuant to which the investment manager will provide the investor with discretionary investment management services.

The investment management agreement normally provides that the investment manager is responsible for exercising final investment discretion as to whether the fund shall invest in prospective investee companies. 

Operation of the Fund - Claiming tax relief.

Once an investment has been made in an investee company, the investee company directors typically prepare and send off SEIS and / or EIS compliance certificates to HMRC.

When an investee company has been trading for four months, or alternatively (in the case of SEIS investment only) once 70% of the monies raised has been spent, the investee companies will apply to HMRC to obtain an EIS 3 Form or SEIS 3 Form as the case may be.

Investors must send these forms to HMRC with their tax returns in order to claim any income and capital gains tax reliefs in respect of the amount invested in that Investee Company. Relief must be claimed no later than five years after 31 January following the year of assessment in which the investment was made.

SEIS and EIS Tax Reliefs for funds

SEIS and EIS income tax relief for investments in a fund made after 05 April 2017 can be claimed in the 2017/2018 tax year, or can be carried back to the 2016/2017 tax year.

1. EIS Tax Reliefs

To obtain the tax reliefs described below, it is necessary to subscribe for shares in EIS qualifying companies and claim the relief. The summary below is based on current law, and gives only a brief outline of the tax reliefs. It does not set out all the rules which must be met by EIS qualifying companies and an investor. The tax reliefs will only be relevant to Investors who pay UK income tax and/or wish to defer a capital gain.

(a) Income Tax Relief – 30%

Individuals can obtain 30% income tax relief on the amount subscribed for shares in EIS qualifying companies (up to an annual maximum £1 million for the 2016/2017 tax year), although relief will be denied for investment into an EIS qualifying company with which the individual is connected. Spouses and civil partners can each separately subscribe up to £1 million.

The relief is given against the individual’s income tax liability for the tax year in which the shares are issued unless the individual makes a Carry Back Relief claim. Relief is limited to an amount that reduces the Investor’s income tax liability for the year to nil.

(b) Carry Back Relief

Carry Back Relief claims may be made for amounts subscribed for shares in EIS qualifying companies, such that an investment is treated for tax relief purposes as having been made in the tax year before the tax year in which the investment was actually made. In effect, and provided no 2015/2016 EIS investments have already been made, this allows an investor to invest up to £2 million in 2016/2017 and claim full tax relief.

(c) Capital Gains Tax Deferral

To the extent to which a UK resident Investor (including individuals and certain trustees) subscribes for Shares, he can claim to defer paying tax on all or part of a chargeable gain. The gain may have arisen on the disposal of any asset, or a previously deferred gain may have been brought back into charge. Although there is a limit for income tax relief (see (a) above) and for the exemption from capital gains tax upon a disposal (see (d) below), there is no limit on the amount of EIS qualifying investments which can be used to defer a gain. If the Investor dies whilst still holding Shares, the deferred CGT liability is extinguished entirely. Shares in EIS Qualifying Companies must be issued within one year before and three years after the date of the disposal which gives rise to the gain or the date upon which a previously deferred gain crystallises. The gain is deferred until there is a chargeable event such as a disposal of Shares or an earlier breach of the EIS rules.

For gains made from 06 April 2016 onwards, CGT has been charged at 10% and 20% for individuals (the applicable tax rate depends on the total amount of the individual’s taxable income and will be 20% for an individual liable to higher rates of income tax (28% for certain residential property assets); 28% for trustees or for personal representatives of someone who has died; and 10% for gains qualifying for Entrepreneurs’ Relief (subject to a maximum lifetime limit of £10 million).

When a previously deferred gain crystallises, the rate of CGT then payable will depend upon the legislation that is in force at that time, and may be greater or lower than the rate that would have applied had Capital Gains Deferral not been claimed. If Entrepreneurs’ Relief was available on the gain deferred it will also be available when the gain comes back into charge for disposals on or after 03 December 2014.

(d) Capital Gains Tax Exemption

Any capital gains realised on a disposal of Shares in an EIS Qualifying Company after the Three Year EIS Period, and on which EIS relief (see (a) above) has been given and not withdrawn, will be capital gains tax free. Any capital gains realised on a disposal within the Three Year EIS Period will be subject to CGT.

(e) Loss Relief against income or gains

Tax relief is available at any time in respect of any loss realised upon a disposal of shares in an EIS Qualifying Company on which EIS income tax relief (see (a) above) or CGT Deferral (see (c) above) has been given and not withdrawn. The amount of the loss (after taking account of any income tax relief initially obtained) can be set against the individual’s gains in the tax year in which the disposal occurs, or, if not fully used, against gains of a subsequent year. Alternatively, on making a claim, the loss net of income tax relief may be set off against the individual’s taxable income of either the tax year in which the disposal occurs, or the previous tax year. If the circumstances are such that EIS tax reliefs have been withdrawn, it may still be possible for an investor to claim loss relief, for an amount equal to the economic loss sustained. Where only CGT Deferral has been claimed, loss relief may be restricted due to the cap on income tax reliefs.

(f) Inheritance Tax – Business Property Relief

Although not an EIS tax relief as such, an investment in an EIS Qualifying Company will normally qualify for 100% relief from IHT under current legislation, provided the investment has been held for at least two years and is still held at time of death. There is no upper limit on the amount of IHT relief which can be claimed.

Trusts

Reliefs are available to UK resident Investors as trustees of discretionary or life interest trusts. Apart from being attractive to individual Investors who are UK resident for tax purposes, the Fund offers tax planning opportunities to trustees of certain trusts.

Capital Gains Deferral, as described above, can be claimed on the amount subscribed for Shares in EIS Qualifying Companies against any chargeable gains if the Investment is made within one year before and three years after the date of the disposal which gives rise to the gain or the date upon which a previously deferred gain crystallises.

Loss Relief is available under the normal capital loss rules in respect of any losses incurred on Investments made by the Fund.

Inheritance Tax: discretionary trusts can benefit from BPR on EIS Investments made by the Fund, provided they have been held by the trustees for two years.

Date for claiming tax relief

The relevant dates for income tax relief, from a tax year perspective, are the dates on which Investments are made into each of the Investee Companies, rather than the date in which you subscribed to the Fund. The latest date you can file a claim for EIS relief is five years after 31 January following the tax year to which the claim relates.

EIS3 certificates

On investment into each Investee Company an application on your behalf will be made to HMRC for EIS3 certificates for each of the investments. The application to HMRC cannot be made until the Investee Company has carried on its trade for a minimum of four months. Subject to this, EIS3 certificates are typically sent out to investors within eight weeks of each underlying investment. The EIS3 certificate enables you to claim your income tax relief and capital gains tax deferral, normally by making the appropriate entries on your own tax return.

2. SEIS Tax Reliefs

To obtain the tax reliefs described below, it is necessary to subscribe for Shares in SEIS Qualifying Companies and claim the relief. The summary below is based on current law, and gives only a brief outline of the tax reliefs. It does not set out all the rules which must be met by SEIS Qualifying Companies and an Investor. The tax reliefs will only be relevant to Investors who pay UK income tax and/or wish to exempt a capital gain.

(a) Income Tax Relief – 50%

Individuals can obtain 50% income tax relief on the amount subscribed for Shares in SEIS Qualifying Companies (up to an annual maximum £100,000 for the 2016/2017 tax year) although relief will be denied for investment into an SEIS Qualifying Company with which the individual is connected. Spouses and civil partners can each separately subscribe up to £100,000.

The relief is given against the individual’s income tax liability for the tax year in which the Shares are issued unless the individual makes a Carry Back Relief claim. Relief is restricted to an amount which reduces the investor’s income tax for the year to nil.

(b) Carry Back Relief

Carry Back Relief claims may be made for amounts subscribed for Shares in SEIS Qualifying Companies, such that an investment is treated for tax relief purposes as having been made in the tax year before the tax year in which the investment was actually made, subject to the appropriate limit for that tax year.

(c) SEIS CGT Exemption (SEIS Reinvestment Relief)

If an investor realises a capital gain by disposing of an asset of any kind and invests the gain in shares in an SEIS Qualifying Company, up to one half of that gain can receive exemption from CGT[1]. It is noted that the investment must be within the same tax year.

(d) Capital Gains Tax Exemption

Any capital gains realised on a disposal of Shares in an SEIS Qualifying Company after the Three Year SEIS Period, and on which SEIS relief (see (a) above) has been given and not withdrawn, will be capital gains tax free. Any capital gains realised on a disposal within the Three Year SEIS Period will be subject to CGT.

(e) Loss Relief against income or gains

Tax relief is available at any time in respect of any loss realised upon a disposal of shares in an SEIS Qualifying Company on which SEIS income tax relief (see (a) above) has been given and not withdrawn. The amount of the loss (after taking account of any income tax relief initially obtained) can be set against the individual’s gains in the tax year in which the disposal occurs, or, if not fully used, against gains of a subsequent year. Alternatively, on making a claim, the loss net of income tax relief may be set off against the individual’s taxable income in either the tax year in which the disposal occurs, or the previous tax year.

If the circumstances are such that SEIS tax reliefs have been withdrawn, it may still be possible for an Investor to claim loss relief, for an amount equal to the economic loss sustained, however, the amount of the relief would be restricted to the greater of £50,000 or 25% of adjusted total income for Income Tax purposes.

(f) Inheritance Tax – Business Property Relief

Although not an SEIS tax relief as such, an investment in an SEIS Qualifying Company will normally qualify for 100% relief from IHT under current legislation, provided the investment has been held for at least two years and is still held at time of death. There is no upper limit on the amount of IHT relief which can be claimed.

Date for claiming tax relief

The relevant dates for income tax relief, from a tax year perspective, are the dates on which Investments are made into each of the Investee Companies, rather than the date in which you subscribed to the Fund. The latest date you can file a claim for SEIS relief is five years after 31 January following the tax year to which the claim relates.

SEIS3 certificates

On investment into each Investee Company an application on your behalf will be made to HMRC for SEIS3 certificates for each of the investments. The application to HMRC cannot normally be made until the Investee Company has carried on its trade for a minimum of four months or, if earlier, after the Investee Company, has spent at least 70% of the money raised through issue of SEIS qualifying Shares. Subject to this, SEIS3 certificates are typically sent out to Investors within eight weeks of each underlying investment. The SEIS3 certificate enables you to claim your income tax relief and capital gains tax exemption, normally by making the appropriate entries on your own tax return.

[1] In order to obtain this CGT exemption, SEIS Income Tax Relief must be claimed on the acquisition of the shares.

SEIS and EIS Qualifying Companies

Each investee company in which the fund invests must initially (i.e. at the time of issue of the shares) not be listed on a recognised stock exchange (as defined for the purposes of SEIS and EIS Relief) and there must be no “arrangements” in place for it to become so listed. In addition, throughout the Three Year SEIS and EIS Periods, it must not be a subsidiary of, or be controlled by, another company. It must either exist to carry on a qualifying trade or else be the parent company of a trading group and there must be no “arrangements” in existence for the Investee Company to become a subsidiary of, or be controlled by, another company.

A trading group is a group in which, directly or indirectly, more than 50% of the shares of each subsidiary are held by another member of the group, but any subsidiary employing any of the money raised by the issue of Shares must be a qualifying 90% subsidiary. Non-qualifying business activities (broadly, investment activities and non-qualifying trades) must not comprise a substantial part of the business of the group as a whole. The qualifying business activity for which the money is raised by the issue of Shares must be a trade conducted on a commercial basis and with a view to the realisation of profit.

Although it is possible for qualifying activities to be carried on anywhere in the world, the company that issues the shares must have a “permanent establishment” (broadly, a taxable presence) in the United Kingdom.

For EIS purposes, the value of the gross assets of the Investee Company and any subsidiaries must not exceed £15 million immediately before the issue of Shares and £16 million immediately afterwards. The maximum EIS fundraising per Investee Company is restricted to an all-time maximum of £12,000,000 (£20,000,000 for “knowledge-intensive” companies). Generally, companies older than seven years cannot receive EIS monies. The relevant shares must be issued to raise money for the purpose of a qualifying business activity so as to promote business growth and development. Employing money raised on the acquisition of an interest in another company, which is or becomes a 51% subsidiary of the company, a trade or goodwill or intangible assets employed for the purposes of a trade does not amount to employing money raised for the purpose of a qualifying business activity.

Subject to certain exceptions, the maximum EIS fundraising per Investee Company is restricted to £5 million per year and a lifetime limit of £12 million. The maximum number of full-time employees (or full-time equivalent) in the Investee Company at the time of Investment is restricted to fewer than 250.

For SEIS purposes, the value of the gross assets of the Investee Company and any subsidiaries must not exceed £200,000 immediately before the issue of Shares. The maximum SEIS fundraising per Investee Company is restricted to an all-time maximum of £150,000 and the maximum number of full-time employees (or full-time equivalent) in the Investee Company at the time of Investment is restricted to fewer than 25.

It is not possible for a company to qualify for SEIS relief if it has previously issued shares on which EIS Relief has been claimed, or has issued shares to, or received an investment from, a venture capital trust. If a company issues shares on which SEIS Relief is claimed, it is possible for it to issue subsequent shares on which EIS Relief may be claimed.

Most types of trades are qualifying trades for EIS and SEIS purposes but the following are excluded:

  • Dealing in land, commodities or futures, or in shares, securities or other financial instruments;
  • dealing in goods otherwise than in the course of an ordinary trade of wholesale or retail distribution, or acting as a wholesaler or retailer of goods of a kind which are collected or held as investments if stock is not actively sold;
  • banking, insurance, money lending, debt factoring;
  • hire purchase financing or other financial activities;
  • leasing, except certain lettings of ships, or receiving royalties or licence fees (subject to certain exceptions, most particularly in relation to self-generated intellectual property);
  • providing legal or accountancy services;
  • farming and market gardening;
  • holding, managing or occupying woodlands or forestry or timber production;
  • property development;
  • shipbuilding;
  • producing coal and/or steel;
  • operating or managing hotels or similar establishments;
  • operating or managing nursing homes and residential care homes;
  • generation or export of electricity or power;
  • production of gas or fuel; and
  • providing services to a trade consisting of any of the above carried on by a “connected person.”

For EIS the trade of the company must generally be less than seven years old at the time of investment.

Companies “in difficulty” cannot receive SEIS or EIS investment. In practice, HMRC accept that a company will not be treated as “in difficulty” within three years of its formation or if it is able to raise funds from existing shareholders or the market.

Shares only qualify for SEIS or EIS Relief if they are ordinary shares which do not, at any time during the Three Year EIS or SEIS Period, carry any present or future preferential right to dividends (other than to certain fixed rate non-cumulative dividends) or to an Investee Company’s assets on its winding up, or any present or future right to be redeemed.

Unapproved Fund Status

As with most funds, the Fund has not been approved by HMRC under Section 251 of the Income Tax Act 2007 (for EIS purposes). This means that the Investor can obtain SEIS or EIS income tax relief only in the tax year in which investments in Qualifying SEIS or EIS Companies are made by the Fund (i.e. the tax year in which the Fund invests), or in the immediately preceding tax year.

CGT Deferral is given by reference to the date on which the Fund makes its investments. Generally, the Investment Manager reserves the right to return a small surplus of cash if it concludes that it cannot be properly invested.


Please note that this is only a condensed summary of the taxation and legal legislation and should not be construed as constituting advice which an investor should obtain from his or her own investment or taxation adviser before applying for an investment in any fund. The value of any tax reliefs 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 SEIS or EIS legislation.



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