The Seed Enterprise Investment Scheme was introduced last year, with special tax reliefs being available under it for 2012/13 and it has now been announced that these are to be continued for the current tax year 2013/14 with one amendment.
The tax reliefs divide into three different categories, these being income tax reliefs, capital gains tax reliefs and an exemption from inheritance tax. Although by definition the companies raising finance under the scheme will be very high risk for investment purposes, as will be seen from the summary below, those who can make maximum advantage of the reliefs can effectively transfer most of the risk to the taxpayer. Nevertheless potential investors should take expert financial advice as well as tax advice before proceeding with any investment of this kind because of the specialised nature of the investment. In particular the tax rules are very detailed and only a summary of them is set out in this memorandum. Failure to comply with every aspect of the rules can mean the loss of all tax reliefs and with consequent assumption of the entire risk by the investor.
The Scheme In Outline
The SEIS scheme is directed at fledgling trading companies, these being defined as those with gross assets of no more than £200,000 before the share issue, and fewer than 25 employees. The company’s trade must be less than 2 years old. Some types of trade are excluded from the scheme, examples being farming, woodlands, nursing homes and property development.
Under SEIS the investor must not be an employee of the company in the three year period commencing on the date of the issue of the shares, although somewhat surprisingly the investor can be a paid director of the company and one of the founders of it. He or she must not hold more than a 30 per cent interest in the company at any time from the date of incorporation of the company to the third anniversary of the date of issue of the shares. This 30 per cent test is subject to some detailed rules which aggregate holdings of other family members and associates. Therefore although husband and wife may make separate use of the SEIS reliefs, it will not be possible for them both to invest in the same company unless their holdings together give them an interest of 30 per cent or less in the company concerned.
At least 70 per cent of the money raised under the scheme must be used by the company in its business before HMRC will issue a certificate of eligibility for the investor’s tax relief.
The Relief
The maximum subscription for SEIS in any tax year to any investor is £100,000 and the income tax relief is at the rate of 50% of the amount subscribed. This is a flat rate relief and is not geared to the tax rate of the investor, although it operates as a deduction from tax payable so full relief requires an equivalent amount of income tax to be payable. There is a 'carry-back' facility which allows all or part of the cost of shares acquired in 2013/14 to be treated as though the shares had been acquired in 2012/13 tax year and relief given for the earlier year, up to the limit of £100,000 in any one year.
It is very important that the investor does not start with making a loan to the company with a view to converting it into an issue of shares at a later time. An investment under the scheme must raise new funds for the company and cannot be made in exchange for an amount of loan previously made. The shares must be paid for immediately on issue.
Conditions To Be Satisfied After Investing
After an investment is made, there remains a qualifying period of three years throughout which there must be no return of value to the investor from the company. Return of value is widely defined to include the redemption of shares or securities, loan repayments and certain other types of payment not listed as being acceptable. This does not however prohibit dividends being paid on the shares.
After the three-year period, restrictions no longer apply, and if it should choose to do so the company could then discontinue its qualifying trade and branch out into other activities which would not have been qualifying under the seed enterprise investment scheme if carried out when the investment was made.
Loss Relief
If the investment should prove to be unsuccessful and ultimately a loss arises on the disposal of the shares, that loss can be claimed for income tax relief. The loss will be the difference between the amount, if any, received on disposal of the shares and the initial amount of the investment, less the amount of income tax relief which was received. For example, if an SEIS investment is now made of £100,000 for which £50,000 of income tax relief is given, should the investment prove to be a total loss an amount of £50,000 can be claimed in the year of loss as a deduction from taxable income. For a 40 per cent taxpayer, this will mean that most of the loss is covered by tax relief, i.e. £50,000 on investment, and £20,000 on the ultimate loss claim, a total of £70,000 in tax relief. For a 45 per cent taxpayer the total income tax reliefs in these circumstances are £72,500.
The Capital Gains Tax Reliefs
There are principally two capital gains tax reliefs for SEIS investments. The first is that, for shares which qualified for income tax relief and which are retained for the three-year qualifying period without the relief being withdrawn, they then become exempt assets for capital gains tax purposes. Accordingly if they are realised at a profit, that profit will be tax free.
The second capital gains tax relief is that for 2012/13, 2013/14 and 2014/15 gains on other assets sold in those years can be ‘held over’ into an SEIS subscription. Hold over relief is a mechanism by which the gain realised on an asset can be deferred so that tax is not payable for the year in which that asset was disposed of but instead the gain would usually be charged as and when the new asset acquired is sold. The SEIS relief is more generous than the normal hold over relief just described. The held over gain is only brought back into charge to tax if the investment is sold, or if some other disqualifying event takes place in the three year period relevant to the main reliefs. After that, the held over gain becomes completely exempt from capital gains tax.
The available hold over relief is slightly different for the year 2012/13 as compared to the years 2013/14 and 2014/15, as detailed below.
- The 2012/13 hold over
For 2012/13 the full amount subscribed for the shares qualifies for capital gains tax hold over relief in relation to the gain on any other asset disposed of in that year. For example, suppose that a holiday home was sold on 1 December 2012 realising a profit of £100,000. If the taxpayer makes an SEIS investment of £100,000 on or before 5 April 2013, he can ‘hold over’ all the gain into the SEIS investment so that the gain of £100,000 is no longer taxable. Furthermore under SEIS, so long as the investment is held for the three year period, as mentioned in the previous paragraph above, the deferred gain thereafter becomes totally exempt from capital gains tax.
- The 2013/14 and 2014/15 hold over
In fact a better result can easily be achieved if no other SEIS investment had been made in 2012/13; the investor could then claim the carry back relief to treat the investment as having been made in 2012/13, in which case the full £100,000 could be held over. If another
SEIS investment of £100,000 had already been made in 2012/13, an alternative would be to claim 30 per cent income tax relief under the enterprise investment scheme (EIS), instead of 50 per cent under SEIS, in which event all the gain can be held over, although it will come back into charge to tax if the EIS shares are ever disposed of. The generous exemption of a held over gain from tax does not apply under EIS. For this reason a 2013/14 claim under SEIS will normally still be more tax efficient than an EIS claim.
The Total Income Tax and Capital Gains Tax Reliefs
Assuming that a gain of £100,000 for 2012/13 is held over into an SEIS investment of that amount, saving 28 per cent capital gains tax (amount £28,000), it will be seen that, even for an investment which in the course of time proves to be a complete loss, the total tax reliefs can amount to £100,500, which is more than the amount invested. This is calculated as £72,500 of income tax reliefs as explained above and £28,000 of capital gains tax reliefs. For gains in 2013/14 SEIS allows only 50 per cent hold over so the maximum potential saving is £86,500.
Successful Investment
If the investment proves to be successful, the total return can be spectacular. If one invests £100,000 in new SEIS and after three years it has doubled in value, enabling the shares to be sold for £200,000, under SEIS there is no capital gains tax on the gain. Also, the upfront investment, after 50% income tax relief and maximum 28 per cent capital gains tax hold over relief costs the investor as little as £22,000. The SEIS investor's return on the investment is therefore 809 per cent.
The Inheritance Tax Exemption
Shares issued under both the SEIS schemes are exempt from inheritance tax once they have been held for a two-year qualifying period. There is no limit on the value of the shares qualifying for this exemption. Furthermore, there is no recapture of any of the other tax reliefs detailed above on the death of the taxpayer concerned.
The inheritance tax exemption for SEIS shares applies to gifts of the shares both on death and in lifetime. In principle, therefore, shares acquired under either scheme can, after the 3 years, be used to shelter gifts of other assets into a family trust made in lifetime. The trust could be formed with an initial gift of the shares and the trustees could then sell those to the settlor in exchange for other assets held by the settlor of equivalent value. This procedure does however require detailed advice.
Summary
The tax reliefs under the Seed Enterprise Investment Scheme are very generous, although it must be acknowledged that investments of this type tend to be either successful or highly unsuccessful. A good principle to keep in mind is that no investment should be made solely for tax reasons, but the overriding consideration should be the soundness of the company concerned from an investment point of view.
For General Information Only:
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein. If you would like to discuss any of the points raised within this memorandum please contact either Charles Little FCA or Anthony Brice FCCA on 01234 301000
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