Don’t fall into the EIS trap!

With the 31 January tax return filing deadline fast approaching, tax agents and their clients will be finalising the various claims and elections to be made to HMRC.

Amongst these will be claims for the capital gains tax exemption on disposals of qualifying Enterprise Investment Scheme (‘EIS’) shares.  The recent case of Robert Ames v HMRC (2015) explains how costly it can be to get things wrong.

Background

The EIS is designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who subscribe for new shares in those companies.  There are three reliefs:

  1. Relief against the investor’s income tax bill of up to 30% of the investment;
  2. The ability to defer gains made on other disposals (‘reinvestment relief’); and
  3. A capital gains tax exemption on disposal of the shares after three years.

One of the additional conditions of relief no. 3 that the investor has at least some income tax relief (i.e. relief no. 1) attributable to the shares.

Robert Ames

In 2003 Mr Ames invested £50,000 in shares in a sky-diving company.  Far from plummeting, however, the company did well, and in 2011 he sold the shares for more than £300,000.

HMRC had granted the company with EIS advance assurance when it issued the shares in 2003 and so, given that more than three years has passed, Mr Ames thought his gain would be exempt.  However, roll back to 2003 when the investment was originally made and Mr Ames had income of less than £100 – easily covered by the personal allowance.  As he had no income tax liability he did not claim the EIS income tax relief – big mistake.  HMRC successfully argued that the shares did not qualify for EIS relief and he had to pay CGT at normal rates – ouch!

Avoiding the trap

The lesson from the Ames case is clear:  to safeguard the CGT exemption on EIS shares there must be at least some income tax relief claimed.  Interestingly, there is no de minimus – a claim for as little as £1 will be sufficient.  Clients with no income or income covered by the personal allowance will need to take steps to generate taxable income against which the relief can be claimed. There are a number of ways of doing this. For example:

  1. Disclaiming the personal allowance (Contrary to popular belief, the personal allowance is not automatic – it has to be claimed.  It is possible to disclaim enough personal allowance to leave as little as £1 as income to be relieved by EIS).
  2. Generating income e.g. by cashing in bonds, earning interest etc.
  3. Disclaiming other reliefs (e.g. capital allowances) to generate taxable income.

Advisers need to be alive to this issue as we approach 31 January!

 

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