Enterprise Investment Scheme – was 80% of the subscribed share capital “employed” in the qualifying company's trade within the 12 months from subscription?

The result of this appeal brought to the First Tier Tribunal depended on whether the taxpayer could demonstrate that 80% of the funds contributed to Skye Inns Limited (“Skye”) had been employed in the company's qualifying trade within 12 months from the date of subscription for the purpose of claiming Enterprise Investment Scheme (EIS) relief.

Facts

The taxpayer subscribed shares in Skye enabling it to purchase two pubs/restaurants for the purpose of its trade. On 18 December 2001, the taxpayer subscribed £1,536,684 for further shares in the company with the intention that the money would be used by Skye to expand by purchasing a particular pub and restaurant. When the sale fell through in February 2002, the directors continued with their search for appropriate alternative acquisitions. When a suitable acquisition was not found, it was decided that the better option was to undertake major improvements of existing properties held by the company.

In May 2004, HMRC notified the company that in their view the company did not employ 80% of the funds raised in the 18 December 2001 subscription in its business as its accounts showed that £1,229,071 was on a bank deposit.

The taxpayer contended that had the purchase completed as intended in February 2002, 80% of the money's subscribed on 18 December 2001 would have been “employed” in Skye's business within the required 12 month period. It was argued that the 80% test was satisfied at the very point when the purchase was about to be completed. Alternatively, the directors continued intention to find a replacement acquisition meant that the requirement was met; the tax requirements could not have forced the directors to make an unattractive purchase and therefore the tax test ought to have applied in a flexible manner.

HMRC rejected the taxpayer's argument on the basis that cash reserved and ear marked for a new purchase could not be considered as “employed” in the business even if the company had entered into a contract. The acquisition had to be actually made. In this case there was no contract and as such the taxpayer's position was even weaker.

Decision

The Court did accept the taxpayer's evidence that it remained the directors' intention to employ the money in the trade and the money was never appropriated for any non-trade purposes. However the Court agreed with HMRC that the relevant EIS test could not be satisfied on the basis that the company intended to employ the money in the business. Further the directors' continued objective to find a suitable acquisition did not satisfy the test.

The taxpayer subsequently submitted a different argument – when the directors abandoned the intention of acquiring a property, the test of employing the money in the trade was satisfied because the directors were holding the funds to meet anticipated losses, revenue, and some capital improvements to the existing properties used for the company's trade. The Court rejected this argument and any argument contending that share subscription funds should be treated as “spent” and so “employed in the business” by treating every gross costs of the business as having been met out of the share subscription fund, with all gross income remaining “unspent” on the deposit account.

The only approach according to the Court was to treat funds raised in the share issue as having been “employed in the business” only when actually spent on realistic net increases to the net trading assets or when reserved to supplement the current receipt of the trade. Accordingly, 80% of the funds subscribed for in shares in Skye had not been employed in the company's qualifying trade within the required time period, and therefore the appeals were dismissed.

The full text of the case can be downloaded from http://www.financeandtaxtribunals.gov.uk/Aspx/view.aspx?id=4667