What is the Seed Enterprise Investment Scheme ?
The Seed Enterprise Investment Scheme (SEIS) was set up in 2011 by George Osborne to promote new enterprise and entrepreneurship, which in turn would help economic growth. It extends the existing EIS scheme by targeting smaller, higher-risk companies, although it also introduces stricter qualifying requirements. The scheme helps newer startups to appeal more to investors by offering them a couple of generous tax reliefs.
The first and most commonly mentioned tax relief that investors in an SEIS qualifying company can receive is a reduction in their income tax liability of 50% of the value of their investment (on a maximum annual investment of £100,000). So if, for example, an individual invests £50,000 in an SEIS qualifying company, they can claim a reduction in their income tax liability of up to £25,000. If their income tax liability for the year is less than £25,000 then they can carry back some of the relief to the previous tax year in order to utilise the full tax saving.
Additionally, if an investor receives income tax relief on the cost of shares, then any profits realised upon their sale (if the shares have been held for a minimum of 3 years) will be free from Capital Gains Tax (CGT). This could result in a significant tax saving if the value of the company was to increase dramatically. A third form of CGT relief in respect of gains realised on the disposal of assets that were reinvested through SEIS used to be available during the 2012-13 and 2013-14 tax years, however they have since been removed.
It is important to note that there are various conditions that the investor must meet in order to claim the tax reliefs mentioned above, so please contact a professional for advice before committing to an investment.
As a result of these significant tax reliefs, SEIS has become a common pre-requisite for investors looking at startups. This means that they are now becoming essential for startups to have in place. However, as always with HMRC, the rules and processes to qualify are complex.
To qualify as an SEIS investment, both the company and share issue need to meet certain conditions. The key ones are:
- The gross assets of the company should be less than £200,000 and it should have no more than 25 full-time employees.
- The amount a company can raise is capped at £150,000 over a three-year period.
- The company seeking investment must be based in the UK and have a permanent establishment in the British Isles
- The company must be no more than two years old.
- The company has to trade in an approved sector.
- The shares issued have to be ordinary shares, with full rights to dividends & voting. No restrictions can be applied.
- To qualify for income tax relief at 50% of the investment, the shareholder must not be connected with the company. You can be connected in two ways, both applying two years prior to the share issue, and three years following;
- By virtue of your employment – if you are an employee, director or partner
- By virtue of your financial interest – if you or an associate combined (business partner, relatives or your spouse) hold more than 30% of the voting rights of the company.
- All shares have to be paid up in full, in cash, when they are issued.
Applying for SEIS
The process of applying for approval to issue SEIS qualifying shares is quite complicated, and if a mistake is made (which is easily done if one is unfamiliar with the scheme) then the process can become protracted.
It is possible for a company to apply for the SEIS after having received investment and issued shares, however this is generally not advised as there is a risk that it may not qualify. Instead we recommend that the very first step a company takes is to apply for Advance Assurance. If received, the advance assurance is akin to a guarantee from HMRC that if the company were to issue shares under the agreed upon basis, then the investors would qualify for the various reliefs on offer via the SEIS. It is also very common for investors to require a company to obtain Advance Assurance before they invest. Therefore the typical procedure of applying for the SEIS is as follows:
- Apply to HMRC for Advance Assurance to issue qualifying shares under the SEIS – this involves sending a myriad of documents and information about the company to HMRC so that they can asses its eligibility.
- Once the assurance has been received the company can proceed with issuing the shares. As with all stages of the process, care should be taken as the company must receive the money first, and then issue the shares to the investor(s).
- After the shares have been issued, the company will need to complete and submit an SEIS1 form to HMRC. A company cannot do this until it has either been trading for at least four months or it has spent at least 70 percent of the monies raised, however providing it meets this requirement then this step is something of a formality because the advance assurance has been obtained.
- In response, HMRC will send out an SEIS2 form that authorises the company to issue SEIS3 certificates (which HMRC will also provide) to the investors so that they can claim their tax relief.
Failing to complete the paperwork correctly can result in serious consequences, as was the case in X-Wind Power Ltd. After getting HMRCs sign off that their proposed fund-raising would qualify for SEIS relief, in September 2012, X-Wind Power received £90,000 from investors subscribing for shares, on the basis that they would receive 50% income tax relief. Six months later, they submitted a compliance statement to HMRC using form EIS1- this was a mistake as form SEIS1 should have been used. HMRC granted their approval, and the relevant certificates were given to investors. A year later, they tried to raise another round of funding through the SEIS scheme. HMRC denied this as EIS approval had already been given, and SEIS must be used to raise funds first.
In the case presented at the tax tribunal, it transpired that the relevant form had been prepared by the personal assistant of one of the company’s directors, who approved the form for signature by a second director before sending it to HMRC.
As the investment only qualified under the EIS scheme, rather than SEIS, investors could only claim 30% of their investment as tax relief, as opposed to the more generous 50%. The simple clerical error on using the wrong form resulted in a cost of £18,000 in lost tax relief to the investors – an error which was easily avoidable if they had consulted relevant professional advice.
To find out more about raising funds through the EIS or SEIS schemes, or if you are already looking at doing so, we would be happy to help – please see our services page for more details.