Is enterprise investment scheme relief available if problems halt trading?
My client has invested in a company that intends to operate a newly-invented machine that will reprocess used vehicle tyres into useful by-products. The investment was made by subscribing for shares that ought to qualify for enterprise investment scheme (EIS) relief. The money has been spent on buying the machine, but there have been technical difficulties making it work properly. As a result, the machine is idle while investigations are carried out. One possibility is that another company will take over the operation of the machine and will, if it can make it work, buy it. My questions are as follows.
First, given that the EIS company used the money but did not generate any income, can EIS relief be claimed yet? The company has yet to issue the EIS certificates, but I am not sure whether that is for legal reasons or because HMRC are slow.
Second, if the EIS relief can be claimed, what is the effect of the activity stopping either temporarily or permanently? If this machine is sold, but the proceeds are used to pursue some other trading opportunity in the green sector, would the EIS relief on the original share issue be preserved?
I hope that Taxation readers can help with advice here.
Query 18,623 – EIS-man.
Reply by Paul Steward
The company may have not yet even applied for approval as a qualifying company carrying on a qualifying trade by completion and submission of form EIS1 to the Small Company Enterprise Centre (SCEC). This is because the company should normally have been trading for at least four months before the SCEC can process the form and issue form EIS2 to the company. This gives the SCEC’s approval that the company qualifies for EIS purposes. Blank EIS3 forms are also issued. The company can then issue these to its investors who have subscribed for eligible shares.
It is also a condition of the EIS that money raised must be invested within two years from the later of the date of issue of the shares and the date of the trade starting. It seems that the company has been going in the right direction, but the practical difficulties encountered with the newly invented machine mean that it might not yet have started to trade.
The definition of when a business starts to trade is based on case law. HMRC’s view in the Business Income Manual at BIM70510 is that the purchase of machinery is only preparatory. This is based on Birmingham & District Cattle By-Products Co Ltd v CIR (1919) 12 TC 92.
This decision was questioned by Lord Millett in Khan v Miah & Others, HL 2000, [2001] 1 All ER 20. It was held in the latter case that Mr Khan was entitled to a 50% share in the profits even though the restaurant had yet to open when the relationship with his business partners broke down. He had provided most of the money to the business.
The investor should find out what has happened to date at the company. Is it being advised to argue that trading has already started? Was an EIS(AA) form filed to obtain advance assurance? Has an EIS1 form been submitted?
If trading has already begun but has temporarily stopped, this will not be a problem as long as it is only for a brief period. If this goes on for some time or permanently, any EIS relief already given will be withdrawn. But it sounds as though the lack of issue of an EIS3 form to the investor will just continue. If trading has already started, but there is a brief period when it stops and the machine is sold but the proceeds are quickly invested in another trading opportunity in the green sector, trading activity will have been continued with a minor break and EIS relief on the original share issue will be preserved.
The quality of the tax advice taken by the company may be critical to a successful outcome here for all of the relevant parties.
Reply by SWI
EIS relief is available under ITA 2007, Part 5 as long as the investor and the company issuing the shares meet the requirements specified in the legislation. Part 5, Ch 4 sets out the rules for the issuing company. Either the company must exist for the purpose of carrying on a qualifying trade or it must be the parent company of a group whose business involves carrying on qualifying activities. The former test is in point here.
ITA 2007, s 181(1) states that the company must meet the trading requirement throughout the period from the date of the share issue to the termination date. The latter is defined in ITA 2007, s 256(1) as the third anniversary of the issue date or, if the trade had not started at issue date, the third anniversary of it. There is no requirement for the company to be actively trading throughout this period, but there must be a clear intention to
do so.
This is confirmed by the Venture Capital Manual at VCM13050. However, the company cannot issue a certificate until HMRC gives it authority to do so. For this, the company must complete a compliance statement (form EIS1) in accordance with ITA 2007, s 205, but this cannot be submitted until the company has been trading for four months (unless the company was already trading at the date of the share issue).
EIS relief can be claimed even if the company is not trading, as long as the intention to trade throughout remains. There is no specific guidance on how long the company can be inactive for, but the longer the period of inactivity the more likely a claim will be denied.
EIS-man should suggest that the company ought to document its continued trading intention regularly – for example, a monthly board meeting should take place to consider new proposals and the minutes should clearly set out the directors’ intention to trade as soon as possible. If the machine is sold and the proceeds are used to pursue some other trading opportunity in the green sector, the trading requirement would be met and EIS relief would be preserved.
Reply by Toby Jug
Apparently, the company has been carrying out research and development activities with the intention that a connected qualifying trade will derive from these. Such activities are treated as a qualifying business activity as confirmed in HMRC’s Venture Capital Schemes Manual at VCM13060.
To obtain relief under EIS for its investors, the company must first submit to HMRC a compliance statement on form EIS1 confirming that the company satisfies the relevant conditions and will continue to satisfy them as far as they apply to the company. The company cannot issue certificates on forms EIS3 to its shareholders until it receives authorisation from HMRC on form EIS2. The shareholders cannot claim relief until the certificates are received.
VCM14090 confirms that form EIS1 cannot be submitted until the trade or research and development for which the money was raised has been carried on for four months. Also, form EIS1 must be submitted by the later of the following dates:
- two years after the end of the tax year in which the shares were issued; or
- two years after the end of period of four months referred to above.
It is likely that the company should have submitted form EIS1 and the client should check with the company that it has not missed the submission deadline.
Apart from complying with the above procedure, the company must be a qualifying trading company throughout a period of at least three years starting with the date the shares were issued or, where research and development is not applicable and if later, the date that the qualifying trade started. The qualifying research and development or trade must be carried on throughout the relevant three year period.
For shares issued after 21 April 2009, all of the monies raised must be employed for the qualifying trade or research and development within two years of the date of issue or, if the activity consists of preparing to carry on a trade, within two years of commencement of the trade if later.
It is possible that all the conditions have been met by the company despite not generating any income to date. Again, the client needs to check the position with the company.EIS relief will not be obtained if the company stops carrying on a qualifying activity during the relevant three year period, even if that is temporary. That will also be the case if the machine is sold in that period.
