In the first in our 4-part series on some of the tax-efficient investment strategies that help plan for and mitigate eventual capital gains tax liabilities, we’re explaining a little more about the tax advantages of the Seed Enterprise Investment Scheme (“SEIS”).
THE SEED ENTERPRISE INVESTMENT SCHEME
Given that these articles are focused on the tax implications of selling assets, it may seem strange to start with a government scheme that was primarily designed to attract more investment in smaller companies and was less about the end game. However, as every good accountant or tax adviser will tell you, taking the time to plan ahead of making an investment will almost always pay dividends in the long run.
And, whilst it’s true to say that the SEIS was introduced to encourage investment, it would be unfair to say that it doesn’t also consider the end game. Because, in actual fact, it’s one of the most tax-efficient assets you can hold when it comes to mitigating capital gains tax (“CGT”).
INITIAL INVESTMENT INCENTIVES
Before looking at the CGT advantages of SEIS, let’s first look at the tax advantages that the scheme affords to qualifying investors when they make their investment.
The headline draw of the SEIS is the income tax relief available to the investor. Subject to meeting all necessary requirements (which are explored later in the article) the investor can claim income tax relief of 50% of the value of his/her investment, subject to an annual subscription limit of £100,000. That means that at maximum value, a subscriber could claim up to £50,000 off their income tax bill a year as a result of making an SEIS-qualifying investment. And this relief is in no way discriminatory – it is available against income tax however it is originally generated, be that through PAYE; tax on profits from a trade; or profits from a rental business, for example.
The relief works as a credit against the investor’s total tax liability in a given tax year. So, for example, if a taxpayer has paid tax of £60,000 under PAYE and invested £80,000 into an SEIS-qualifying company, they can claim £40,000 of the PAYE as a repayment back from HMRC, immediately halving the cost of their investment.
In cases where the tax hasn’t already been paid at source and the liability only becomes due at the end of the tax year, for example when income tax arises on profits of a property business, the credit will simply act as a tax liability reducer, thereby lowering the amount of tax needed to be paid out by the taxpayer.
It’s important to note that SEIS investments cannot generate more income tax relief than income tax paid or due by the investor. For example, in the illustration above, the £80,000 investment only generates the maximum relief of £40,000 because the taxpayer had a tax liability of more than £40,000.
So, then, suppose the taxpayer had a total tax liability of, say, £20,000 for the year – £20,000 less than the maximum relief available. What would happen then?
The generosity of the SEIS income tax relief provides once more. Although SEIS income tax relief is initially given in the year of subscription, the subscriber is permitted to treat some or even all of their investment as having been made in the immediately preceding tax year.
A taxpayer has paid £20,000 income tax under PAYE during the 2016/17 tax year and £25,000 income tax on trade profits in respect of the 2017/18 tax year. During the 2017/18 tax year, the taxpayer invests £100,000 into Seed Limited, an SEIS-qualifying company.
Now, whilst the total relief available on a £100,000 investment is £50,000, the investor has a total tax liability across both the investment year and the immediately-preceding year of £45,000. They can therefore elect to split their investment and have it treated as being an investment of £60,000 in 2017/18, sufficient to generate a credit of at least the £25,000 tax liability for that year, and an investment of £40,000 in 2016/17, being enough to generate a credit of £20,000 in that year and wipe out their tax liability for that year. The remaining unclaimed relief of £5,000 is lost and cannot be carried back further or carried forward.
It should also be noted that dividend income earned on SEIS investments carries no special treatment. It is taxable under the normal income tax principles attributable to dividend income.
CGT RELIEFS AVAILABLE THROUGH SEIS INVESTMENTS
The CGT reliefs afforded to SEIS investments are two-fold: CGT exemption on any profit from the disposal of the SEIS shares themselves (or qualifying CGT loss if the shares are disposed of at a loss); and CGT reinvestment relief exempting unrelated gains.
The first relief is relatively straight forward. When it comes to selling the SEIS shares, provided the investor has held them for the qualifying period (which is 3 years from the date of investment) and the company and shares have remained qualifying throughout that period, then there should be no CGT payable on the profit made on disposal. If, as is possible when investing in start-up companies, the shares are disposed of at a loss, the loss (normally equivalent to the investment value if nothing is realised on disposal) will be available to offset against other taxable capital gains arising in the same or future tax years.
The second relief is slightly more complicated, yes, but it perhaps gives rise to more tax-saving opportunities for the savvy taxpayer. Like the income tax relief, it operates with a maximum limit of 50% of the SEIS investment or £50,000, whichever is the lowest.
The relief is available in respect of any gains chargeable to CGT in the tax year of investment, or the previous tax year if the income tax carry back facility is claimed. It’s also available against future gains, provided that the SEIS shares are still held and no claim for CGT reinvestment has been made in respect of those particular shares before.
The relievable gains do not have to be related to the SEIS investment, or, in fact, be in respect of a disposal of shares. In addition, whilst it is necessary that a claim for SEIS income tax relief has been made on the investment in order for the investment to be eligible for the CGT reinvestment relief, it isn’t necessary for the income tax relief claim to have been in respect of the full value of the investment.
The effect of the relief is to exempt the qualifying amount from CGT, potentially meaning a saving of up to 28% CGT is achievable on top of the 50% income tax relief also available.
During 2017/18, a taxpayer disposes of an investment property for proceeds of £180,000, making a £40,000 taxable gain on the disposal. In the same tax year, the taxpayer makes a £100,000 SEIS-qualifying investment.
Provided the taxpayer has made a claim for SEIS income tax relief in respect of the investment in 2017/18, they can also exempt up to £50,000 worth of unrelated gains, thereby extinguishing all CGT arising on the disposal of the investment property.
QUALIFYING INVESTORS AND QUALIFYING COMPANIES
The SEIS scheme was designed to encourage investment in small, start-up companies, helping them to find alternative finance when banks wouldn’t be so receptive to supporting their business ambitions. It also aims to match experienced business folk (those likely to have the type of money required to help the company) with inexperienced entrepreneurs, assisting them to manage their way in turning an original idea into a viable business.
Given the generous tax reliefs afforded by the SEIS, the rules dictating qualifying companies and investors are relatively strict and are heavily policed by HMRC. The rules are also quite detailed, but the key provisions are analysed below.
For investors to qualify, they, or their associate(s), must:
- not be an employee of the company from the date they subscribe for the shares through to the third anniversary from that date (although directors aren’t counted as employees for this purpose);
- not hold a substantial interest in the company at any time from company incorporation through to the third anniversary of the subscription date; and
- not, at any time from company incorporation through to the third anniversary of the subscription date, have received a loan that is dependent on their investment (i.e. it wouldn’t have been provided or would not have been provided on those terms were it not for the investment).
For the purpose of these tests, an associate includes an investor’s relatives (but not siblings) and a substantial interest is anything more than 30% of the company’s issued share capital / voting power.
The motives behind making an investment must also be considered, as it is not permitted for the investment to be part of an arrangement or scheme that has tax avoidance purposes.
First and foremost, an investor should look to use SEIS as a means of supporting a business with its early growth and development, getting behind an idea that has taken their interest. However, with both the income tax and the CGT reinvestment reliefs available through SEIS, it is also likely to appeal to those with capital gains to manage or high income tax bills. That being said, the CGT exemption on the shares themselves means that SEIS will often also be useful to the entrepreneur themselves when first considering how to best structure their business venture.
For companies to qualify, they must:
- not be under the control of another company;
- be unquoted, with no plans to become quoted at any time in the foreseeable future;
- have less than £200,000 gross assets;
- have fewer than 25 employees;
- not have previously received any EIS or VCT investment;
- have a permanent establishment in the UK; and
- exist for the purpose of carrying on a qualifying new trade.
For the purpose of these tests, a qualifying new trade is one that does not include, to a substantial amount, any ‘excluded activities’ and one that is no more than 2 years old at the date of investment. In addition, the company cannot have previously carried on a trade other than the qualifying new trade.
The maximum amount that each single qualifying company can raise through SEIS is £150,000 and the SEIS money raised must be used within three years and be spent for the purpose of the qualifying business activity. After that, companies do have the option to move on to the Enterprise Investment Scheme for fundraising, a scheme that we will look at in later articles.
It is possible for companies to apply to HMRC for advanced clearance of their Seed Enterprise Investment Scheme status. This requires the directors of the company to share details of the business and spending plans with HMRC so that they can make a full and informed assessment of the company’s eligibility. It is also only possible if specific investors have already been identified by the company, as HMRC will want to know details about them too.
WITHDRAWAL OF SEED ENTERPRISE INVESTMENT SCHEME RELIEF
Finally, it is possible for Seed Enterprise Investment Scheme relief to be withdrawn from a taxpayer if either the individual or the company are found to have breached the rules during any of the relevant periods, or the initial approval was given based on false or misleading information. Any withdrawal will be costly, and so getting the structure soundly setup and approved at an early stage is always key.