SEIS is a new tax advantaged venture capital scheme. It is focused on attracting investment from individuals in smaller, early stage companies carrying on, or preparing to carry on, a qualifying trade. The relief applies to qualifying investments made on or after 6 April 2012.

The policy objective is to support growth by helping smaller and hence perceived more risky early stage companies which typically face difficulties in raising external equity finance, to attract investment.

The following tax reliefs are available under SEIS to qualifying investors who subscribe for shares in a qualifying company:

• 50% income tax relief on a maximum investment of £100,000 per annum;
• gains on eligible shares are exempt from capital gains tax (“CGT”) provided they have been held for at least 3 years;
• tax relief for allowable losses arising on the disposal of the shares (less any income tax relief previously claimed); and
• perhaps most notably the scheme offers a one off “CGT holiday” - for the first tax year of the scheme only (2012/13) gains realised on the disposal of assets in this period that are reinvested in eligible shares will be completely exempt from CGT, up to a maximum of £100,000.

The quid pro quo for these tax reliefs is that stringent conditions must be met. Some of the main conditions are set out below.

Investor Requirements

The requirements to be satisfied by the investor include inter alia:

• Neither the investor nor an associate of the investor may be an employee of the issuing company or any qualifying subsidiary within the 3 years from the issue of the shares. A director is specifically not an employee for these purposes;
• The investor must not have a “substantial interest” in the issuing company at any time in the period beginning with the incorporation of the company and ending with the third anniversary of the issue of the shares. Broadly, an individual has a substantial interest in a company where that individual possesses or is entitled to acquire greater than 30% of (i) the issued share capital, (ii) voting rights or (iii) entitlement to assets on winding up of the company or any subsidiary of the company;
• The shares must not be issued under any ‘reciprocal’ arrangements i.e. where company owners agree to invest in each other's companies in order to obtain tax relief;
• The shares may not be acquired using a loan made available on terms which would not have applied other than in connection with the acquisition of the shares in question;
• The share must be acquired for genuine commercial reasons and not for tax avoidance purposes.

General Requirements

These include inter alia:

• There must be no arrangements at the time of the investment for the shares to be sold;
• The shares issued by the company to the investor must be ordinary shares, they must be fully paid up in cash and must not be redeemable. The shares can carry some preferential rights, but not to assets in a winding up or to cumulative dividends.
• Before the third anniversary of the issue of the shares, all the money raised by the share issue must have been spent on the qualifying business activity for which the money was raised.

Company Requirements

The qualifying criteria are similar for companies under both the SEIS and the EIS schemes and include inter alia:

• The company must be an unquoted trading company which is not under the control of any other company;.
• The trade must be a “qualifying trade” i.e. one which is conducted on a commercial basis with a view to the realisation of profit. As with EIS, a trade will not qualify if it consists wholly, or substantially, of “excluded activities”. Examples of excluded activities include dealing in land, shares, securities or other financial instruments.
• The company must have a “Permanent Establishment” in the UK.

Notable Differences with EIS

There are a few key differences between SEIS and EIS which should be highlighted.

• Under SEIS, the company must be a new venture and the trade must be less than 2 years old. This restriction does not apply to EIS.
• A qualifying SEIS company must not have previously raised funds under EIS or VCT.
• Within three years, the company must have spent all the monies raised by the share issue for the purposes of a qualifying activity. This is crucial as if this condition is not met, investors may lose their tax relief.
• The maximum funds a company can raise under SEIS is £150,000. This is a cumulative limit, not an annual limit. In contrast under EIS, while the amount that can be raised annually by a company is £5m, there is no cumulative limit.
• SEIS investors can only claim their 50% tax relief on a maximum investment of £100,000 per year, compared to an annual investment limit under EIS of £1m relievable at 30%.
• SEIS companies are more restricted in terms of size. They must have fewer than 25 employees at the date of the SEIS investment (compared to 250 for EIS) and gross assets of SEIS companies must not exceed £200,000 at investment. The commensurate gross asset figure for EIS companies is £15m immediately before the investment.

The advance clearance procedure can be used, whereby companies can apply to HMRC's Small Company Enterprise Centre for advance assurance that the shares will qualify under the scheme.

SEIS – Opportunities and Pitfalls

• The big advantage of SEIS from a tax perspective is the protection from downside risk combined with the upside tax reliefs. The combination of 50% income tax relief, a 28% saving on capital gains tax if the CGT holiday is taken advantage of in 2012/13 and, (where the investment makes a loss) a claim for relief against income at 45% (note that the current highest rate of income tax known as the ‘additional rate’ is proposed to fall to this from 6 April 2013) on the amount invested is very attractive. This adds up to a potential maximum tax relief of 100.5% (being 50%+28%+22.5%). In summary, for certain taxpayers, they may be in a positon where there is no possibility of loss where an investment goes bad and tax free gains where an investment succeeds.
• Interestingly, in order to take advantage of the CGT holiday in 2012/13, an individual merely needs to reinvest the amount of the gain realised into SEIS shares. This is in contrast to other similar CGT reliefs which generally require the individual to reinvest the whole of the proceeds received (as distinct from the gain realised)
• One of the requirements for companies to qualify for SEIS status is that the start up company must not have been controlled by another company in the period from the date of incorporation. This means that purchasing an “off the shelf” company from corporate formation agent will jeopardise the availability of the relief at the outset as will have been under the control of a corporate shareholder at some point after incorporation. This is in contrast to EIS where the same control requirement only applies from the date of issue of the shares to the investor so the same problem does not arise.
• The Government has introduced a “disqualifying purpose test” which is aimed at preventing artificial schemes designed with a tax avoidance motive from qualifying for tax relief. This will apply to all EIS, VCT and SEIS shares issued on or after 6 April 2012. Essentially, the main aim is to ensure that companies are not set up for the purpose of accessing venture capital relief. There is quite a lot of uncertainty around this at present, and HMRC draft guidance states that no advance assurance will be given in relation to this condition and it will be only tested once a formal application for relief has been made. As the guidance is in draft at present it is hoped HMRC will provide greater clarity and an opportunity for advanced clearance once it is finalised.
• As with EIS, investors can have their tax relief reduced or withdrawn where they are in receipt of value from the company. The term “receipt of value” is widely defined in the legislation and can include the repayment of a debt owed to the investor by the company in certain circumstances. In practice this condition is not always appreciated and is an area in which advice should be sought to ensure that tax relief is not lost.

SEIS should encourage investment in start up companies which is to be welcomed in the current economic environment given the continuing lack of availability of finance. However, the legislation is complex and well intentioned investors may fall foul of some of the legislative pitfalls, e.g. through the use of an off the shelf company as discussed above.

Additionally, the disqualifying purpose test as discussed above introduces an extra stratum of uncertainty into the process and one hopes HMRC guidance will provide more certainty in this area when finalised. It is vital that individuals seeking to avail of SEIS tax reliefs, or companies seeking funding under SEIS take tax advice as a fundamental part of their planning in this area.

Neil Kelly is a Business Tax Advisory Manager with Ernst & Young LLP

Tele: + 44 (0) 2890 443614

Email: nkelly3@uk.ey.com