5 easy SEIS/EIS mistakes companies need to avoid

Companies who are seeking to attract investors through SEIS or EIS need to pay careful attention to the stringent rules, or risk falling into common pitfalls that will result in missing out on securing future funding. Since their introduction, over 52,000 companies have secured investment amounting to £27 billion. What’s more, a report by the British Business Bank (BBB) and the UK Business Angels Association (UKBAA) found that 53% of angel investors would not consider investing in a business unless it were eligible for SEIS or EIS. This makes the two generous tax relief schemes a valuable incentive to both companies and investors. However, mistakes when it comes to remaining eligible are notoriously simple to fall into, so we outline 5 common SEIS/EIS mistakes to watch out for.

Why it is important for companies to maintain their SEIS or EIS eligibility status

Companies should take a pragmatic view when it comes to maintaining their SEIS or EIS eligibility. It’s important to maintain the eligibility status regardless of whether funding has been secured for the following reasons:

• It’s beneficial to uphold the company’s reputation as it may encourage current investors to continue investing
• Moreover, upholding the company’s reputation and eligibility may attract new investors as well
• Failing to maintain eligibility may alert HMRC to take a  extra scrutiny when it comes to your other tax affairs such as  corporation tax, PAYE, or even R&D tax credits
• Depending on your agreement with your investors, you could be in breach of contract and face civil charges

What happens if a company is no longer eligible for SEIS or EIS?

In practice, for any benefits that arise from SEIS or EIS to become available, cash must have been paid into the company and shares must have been issued to the investor. The exchange is what activates both these schemes. Therefore, it is reasonable to assume that the company was eligible at that moment in time in which the investment was made.

Nevertheless, it is very easy for a company to fall out of eligibility simply by not adhering to the tax scheme requirements throughout the necessary 3-year time period that will qualify the investor for all the tax benefits. At this point however, the company would have already received the funds. From HMRC’s perspective, there are no implications on the company as it does not receive any tax breaks.

On the other hand, when it comes to the investor, HMRC are much more concerned with clawing back any tax relief already received as well as withdrawing any promised future tax relief once a company is no longer eligible for SEIS or EIS. The investor will therefore suffer from:

• Being required to pay back any income tax relief they have already received (50% for SEIS and 30% for EIS)
• Losing inheritance tax relief which means, by leaving shares in their will, this will be subject to 40% inheritance tax (unless disposed of as a gift which has been received at least 7 years prior to death)
• Losing capital gains tax (CGT) relief (disposing of their shares even after the 3 years have elapsed will mean they are subject to CGT if there is a gain)
• Losing loss relief if the shares are sold at a loss (where shares are sold at a loss, the loss amount cannot be offset as a capital loss or offset against income)

Are there any exceptions to losing SEIS or EIS eligibility status?

The one exception to when a company loses their SEIS or EIS status, but the investor is still able to retain some of their tax benefits is if the company fails within the three years that the investor needs to hold their shares. In this instance, the investor will still be able to keep any income tax relief that they have already received, as well as claim loss relief. For this to apply, the company cannot be  voluntarily wound up and must be declared insolvent.

5 easy SEIS/EIS mistakes companies need to avoid

To ensure your funding rounds go smoothly, you should watch out for these 5 common SEIS/EIS mistakes. It’s worthwhile to note however, that it is just as easy for an investor to be ineligible regardless of the company’s own eligibility status. It is therefore prudent that both parties are sure of and understand their own responsibilities.

SEIS/EIS Mistake #1: Leaving too much of a time gap between receiving investment and issuing shares

Getting your timings just right will be a common theme amongst the top 5 easy SEIS/EIS mistakes companies make. When it comes to the transaction between receiving investment and issuing shares, it is crucial that shares must be paid in full first with cash only prior to any issuance of shares. However, once funds have been received into the company’s bank account, it is advised that shares are issued straight away without too much of a delay. A prolonged delay may lead HMRC to interpret the transaction as a loan rather than an SEIS/EIS investment. Practically speaking however, the issuance of shares is not necessarily a quick and simple procedure as the company will require a formal valuation. To get around this, both the company and investors could consider using an Advanced Subscription Agreement to allow for more time without risking the eligibility status.

SEIS/EIS Mistake #2: Not issuing SEIS and EIS shares the right way around

It’s not uncommon, or against any rules, for companies to secure both SEIS and EIS funding so long as they maintain their eligibility status under both. In fact, many companies will seek SEIS and EIS funding side by side and many investors choose to make SEIS and EIS investments in the same business. Nevertheless, whilst the prospect of being able to secure significant investment in one go is highly appealing, it is imperative that companies sufficiently pace and order their investment rounds correctly. Raising EIS investment and issuing EIS shares first will mean that a company will no longer be able to go back and use the SEIS scheme. SEIS investment and issuing of SEIS shares must come first. For that reason, even where funding may be secured under both schemes in the same days, companies must leave at least one day between issuing SEIS shares first and EIS shares second.

SEIS/EIS Mistake #3: Forgetting the 30% rule includes “associates”

The 30% rule is easy to understand. Investors cannot receive any more than 30% of a company’s shares. This includes where an investor may have both SEIS and EIS shares, of which the total for both combined cannot exceed 30%. The 30% rule is also all encompassing and covers not only the number of shares or voting rights but can also be based on the nominal value of the shares in issue. However, what some people forget is that this 30% is applied to investors and their associates. An associate is defined as a business partner, a trustee of any settlement that the investor is a beneficiary of, a spouse or civil partner, a parent or grandparent as well as a child or grandchild. It does however exclude siblings.

SEIS/EIS Mistake #4: Not checking if investors have any connections to the company

SEIS and EIS rules state that an investor cannot be an employee in the company. However, it is also important to remember that none of the investor’s associates can be connected with the company in any way either. Therefore, if the investor has any relations that may be employees in the company, this would invalidate any tax relief available through SEIS or EIS. This is also the case where an investor cannot be a director in the company, yet you will find that many investors hold SEIS or EIS shares in their own company. The loophole around this is that the investor must pay fully in cash first, receive shares in the company worth no more than 30%, and then be appointed as a director.

SEIS/EIS Mistake #5: Not spending your SEIS or EIS funds fast enough

Whilst it’s understandable that both investors and the company will want to ensure they’re spending the investment in the most impactful way possible, there is little use holding onto cash funds until the ideal moment. So long as the money is being spent on qualifying business activities, there is no reason to prolong accessing the funds for business use. This is particularly important as the rules state that SEIS investment must be spent within 3 years of receiving the funds and EIS investment must be spent within 2 years of receiving the funds. The time limit helps prevent investors from using the tax schemes as a way to shield their investment from risk whilst being able to access the tax breaks. Not only that, but for SEIS investors to be able to claim their income tax relief, the SEIS3 certificate will only be issued once the company has been continuously trading for a period of 4 months and have spent at least 70% of the investment.

Get help with SEIS or EIS

If you’re struggling to understand the SEIS or EIS compliance requirements, speak to one of our experts today who can provide guidance on the rules as well as more insight into common mistakes to watch out for.