Priority Returns and EIS – The First Instalment

EIS BASICS

The Enterprise Investment Scheme (“EIS”) is an HMRC approved scheme designed to help smaller, higher-risk companies raise finance by offering tax incentives to investors who acquire ordinary shares in the company.The main benefits are a tax credit equal to 30% of the investment (up to £1 million per annum) and exemption from CGT on a sale of the company after three years.

Regular Tax Bite readers will be familiar with the main qualifying criteria that have to be met by the investor and investee company.  One of the conditions is that the investor must not be “connected” with the EIS company in the period running from two years prior to the shares being acquired to three years after.  The main way in which a person will be connected is if they have more than a 30% interest in the company.  The 30% test is by reference to ordinary share capital, issued share capital, voting power and surplus assets on a winding up.

OPPORTUNITY?

The definition does not, however, cover entitlement to either dividends or share of proceeds on a sale of the company.  For that reason, it may be possible in certain circumstances to offer EIS investors an economic interest in excess of 30% whilst continuing to satisfy the connection test rules.

For example: Dragon’s Den Ltd is a high-tech software business currently owned by two brothers, each having invested £1 million.  The business expects to grow quickly with a view to a sale in 3 years’ time.  They need a further £1 million to finance the expansion plan.  Mr Bannatyne, a wealthy investor, is willing to put the money in, but only for 40% of the business.

Clearly if Mr Bannatyne acquires 40% of the shares and they rank equally to the founders shares then he will not qualify for EIS.  As a compromise, Mr Bannatyne agrees to take only a 30% stake but on the proviso that he receives 40% of the proceeds on the anticipated sale.  This would appear not to breach the statutory test.

It is important to note that if the business is wound up (as opposed to being sold) then the investor will only be entitled to 30% of the surplus assets.

Apparently Mr Bannatyne does not think that this Tax Bite is ‘Ridiculous!’

 

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