Start Up Finance with the Seed Enterprise Investment Fund
SEIS is a Government scheme aimed at incentivising investment into so-called “seed-stage” and start up companies.
This note covers the basics of how the scheme works, what tax relief is available and who is eligible for the scheme.
How does the scheme work?
SEIS operates in a similar manner to the Enterprise Investment Scheme, providing income tax and capital gains tax reliefs for individual investors who subscribe in cash for qualifying shares in qualifying companies. Qualifying shares include ordinary shares, and shares with non-cumulative preferential dividend rights.
For shares issued, a qualifying investor can claim an income tax reduction equal to 50% of the money subscribed. This is subject to an annual subscription limit of £100,000 (so the maximum income tax saving is £50,000).
Naturally, relief can only be used to the extent that the individual has an income tax liability. It cannot create a loss or a repayment of tax. However, investors can also use the tax reduction against their income tax liability for the previous tax year. They can also split the reduction between the two tax years.
Capital gains tax
Where income tax relief is available, broadly capital gains realised on share disposal will be tax exempt.
In addition, the scheme includes an exemption from capital gains tax for proceeds of disposals made in the 2013/2014 tax year that are ‘matched’ with investments in SEIS companies during the same period. There is no restriction on the type of capital asset to which this applies, but a gain that would be subject to capital gains tax must be realised on the disposal. It is not necessary to reinvest the entire proceeds of any disposal – only an amount of the proceeds equal to the gain (or part of the gain) to be exempted.
An individual earning £155,000 in taxable earnings during 2013/2014 will be liable to approximately £55,850 income tax. An investment of £100,000 in a SEIS company would generate a tax saving of £50,000 against that tax liability. Leaving a net income tax bill of approximately £5,850.
Furthermore, if the same individual disposed of an investment property (or other capital asset) for £200,000 in the same tax year, realising a gain of £100,000, they would be able to ‘match’ half of the gain to the SEIS investment. Thereby save half of the 28% CGT otherwise payable on that disposal (i.e. £14,000) in addition to the £50,000 income tax saving. If the gain was £120,000, but the individual still reinvested £100,000, the saving would remain £14,000.
The scheme is only available to small ‘start-up’ companies. The company must not have been actively trading at any time before two years before the shares are issued.
The shares must be held for three years to benefit from the full income tax and CGT reliefs above. If SEIS shares are disposed of within three years of their issue, then there is a potential claw-back of the income tax relief claimed (and no CGT exemptions will be available, either on the disposal or in respect of any other disposal the proceeds of which were reinvested in the SEIS shares).
SEIS relief can only be claimed by an investor (via their self-assessment return) once the company has either spent at least 70% of the SEIS monies invested or been actively trading for at least four months (as opposed to preparing to trade or conducting R&D in advance of trading).
This triggers the company to issue a certificate of qualification to the investor to claim relief.
Who can be a qualifying investor?
The SEIS has a number of similarities with EIS in relation to the requirements that have to be met for an individual investor to qualify.
One of the key requirements is that the investor must not hold (directly or indirectly) more than 30% of the company’s ordinary share capital, issued share capital or voting rights. There are no restrictions on how much loan capital in the company the investor can hold (although care must be taken with regard to convertible loan stock).
Investors who are employees of the company cannot benefit from SEIS. However, there is a distinction between SEIS and EIS in that with SEIS, existing or new directors in the company will be eligible (whereas for EIS, the scheme is not generally (subject to certain limited exceptions) available to directors). So, for example, an existing employee could be appointed a director at the time of investment and still qualify for SEIS relief.
Which companies can qualify for SEIS?
Similar to the other venture capital schemes, there are a number of qualifying conditions that the relevant company must meet in order for it to issue shares under SEIS.
One of the key conditions is that the company must exist wholly for the purpose of carrying on one or more “new” qualifying trades. The scheme is limited to companies carrying on what is described as a “genuine new venture”. This would not include a situation where a company has, in the 6 months prior to commencing the new trade, carried on a different trade consisting of the same activities as the new trade. The legislation also excludes situations where trades or activities that have previously been carried on are in effect transferred to the company. This is in part to prevent avoidance schemes of a type that have exploited the EIS regime through (for example) partitioning of existing non-qualifying businesses into new companies established specifically to enable investment to benefit from the tax reliefs.
Companies that had active trades more than two years before the investment do not qualify.
However, the company need not carry on a trade immediately. It can be engaged in research and development with the intention of trading. In addition, the monies raised under SEIS can be used in such R&D and there is no time limit placed on the company starting an actual trade.
Companies can only raise a maximum of £150,000 under the scheme. This is a lifetime limit. Monies raised under SEIS must also be used by the company in its qualifying activity within three years.
The company must not have had investment under EIS or VCT schemes before shares are issued under SEIS. However, it can raise EIS and/or VCT funding after an SEIS round, provided at least 70% of the SEIS capital has been spent in the company’s qualifying activity.
The other main conditions are:
a) the company’s gross assets must not exceed £200,000 immediately before the investment.
b) the company must have fewer than 25 full time employees.
c) the company must have a UK permanent establishment.
d) the company must not be listed on a recognised stock exchange.
e) the company must not be controlled by another company (unless you are a shelf company).
f) the company must not control another company.
g) the company must not be a member of a partnership.
The Rules also contain a number of the following:
a) a requirement that the investment be undertaken for genuine commercial reasons and not with a main purpose of avoiding tax; and
b) the prevention of the terms of issue of the shares including any form of protection against the ordinary risks of investment (eg anti dilution rights which would protect the investor against future fund raising at a lower price)
The introduction of the special CGT exemption for sums reinvested in SEIS companies is also notable. It offers an enticing opportunity for asset holders to liquidate capital and reinvest in start ups. Government has also introduced a further tax break unrelated to SEIS for UK resident non domiciliaries to remit capital to the UK without incurring tax on those remittances if they are investing in qualifying companies. This may allow such individuals to save CGT on remitted capital as well as yield income tax benefits of investment in an SEIS company.
Lastly, it remains to be seen whether the tight restrictions on company qualification (particularly the limit of £150,000 on SEIS funding and the requirement that the company must have spent 70% of the SEIS money before it can go on to raise EIS or VCT funding) will hinder uptake, and to what extent the potential for funds to invest collectively in multiple companies would serve to counteract this.
Contact us if you have a start up and are seeking seed funding through private investors. This culd be via crowdfunding, VC’s, business angels or family members.