The enterprise investment scheme (EIS) provides valuable income tax and capital gains tax (CGT) reliefs to investors. Unfortunately EIS can be easily lost, and one particular trap for the unwary can occur when other share classes are issued or there are changes in share rights.
By way of background, relief against income tax for the funds used to subscribe for new ordinary shares issued in qualifying companies may be claimed by investors up to an annual limit. Where an EIS investor qualifies for income tax relief on shares they may then also be entitled to an exemption from CGT on the disposal of those shares provided that those shares have been owned for the required three year period.
As anyone who looks at EIS regularly knows, there is a long list of hoops that must be jumped through in order for relief to be available. Relief can also be inadvertently lost and in some cases clawed back by HMRC.
One common way relief can be inadvertently lost is as follows.
Very broadly, the shares issued, on which an investor wishes to claim EIS relief, must be non-redeemable ordinary shares which, during the three year period from the date of issue (or the company commencing a qualifying activity, if later) must not carry preferential rights to:
- dividends that depend to any extent on a decision of the company, a shareholder or any other person, or where the right to receive dividends is cumulative (that is, where a dividend which has become payable is not in fact paid, the company is obliged to pay it at a later time).
- assets on a winding up.
- be redeemed.
This is where the ‘beware the preference’ point comes in. If during the three years of ownership of the EIS shares the company wishes to, for example, create a second class of shares or create growth shares, great care must be taken not to give accidently the EIS claiming shares a preference.
An example of where the above situation occurred can be seen in the Abingdon Health Ltd v HMRC  UKFTT 800 (TC) case. Abingdon Health Limited (“Abingdon”) issued shares to third-party investors under EIS. In 2013 Abingdon issued growth shares to its key employees. The growth shares only participated in distributions on winding-up or other return of capital over and above a “hurdle” amount. Broadly, in the view of HMRC, and the FTT, this meant that the ordinary shares issued under EIS had a preferential right over the new class of shares i.e. the growth shares. As such the ordinary shares ceased to qualify for the EIS relief and the EIS relief already claimed was clawed back.
The Upper Tribunal has confirmed that it is not possible to ignore even a small or insignificant preferential right so investors must be careful whenever they look to alter share class rights or create new classes of shares where EIS is concerned.
If you have any questions or would like to discuss any of the points set out in this blog in more detail please contact Rebecca Arthur (Rebecca.Arthur@burges-salmon.com) or Emma Heelis-Adams (Emma.Heelis-Adams@burges-salmon.com).