EIS LEGISLATION AND LEGAL RULES AND CONDITIONS

THE EIS LEGISLATION
This is a summary of the main provisions of the Enterprise Investment Scheme so far as relevant to the Company as set out in Section 289 and subsequent sections of ICTA 1988, Schedule 5B of TCGA 1992, and other relevant legislation.

It does not set out any of the provisions in fulland intending Investors are strongly advised to seek professional advice as to the tax relief that their particular investment will attract and the tax consequences of selling or otherwise disposing of their shares.

BASIC EISA RULES
The reliefs can only be claimed by an individual, or, for Capital GainsDeferral Relief, certain trustees, who subscribe for new eligible shares in a qualifying company. ‘Eligible Shares’ are ordinary shares which carry no preferential rights to dividends or to assets on awinding up, and no rights of redemption.

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INCOME TAX RELIEF
Income tax relief is available to individuals in respect of the amount subscribed for eligible shares in a qualifying company. The relief is 20% of the cost of the shares, to be set against the individual’s income tax liability for the tax year in which the investment was made. Relief can be claimed up to a maximum of £400,000 invested in such shares, giving a maximum tax reduction in any one year of £80,000 providing you have sufficient income tax liability to cover it. (Please note that this relief cannot be set off against dividend income, as the tax credit attached to the
dividend is not recoverable.)

There is a “carry back” facility where shares have been subscribed for in the first 6 months of a tax year (i.e. 6 April to 5 October). The amount of relief due on the cost - subject to a maximum cost of £50,000 (and therefore maximum relief of £10,000) - of half of those shares can be carried back and set against the income tax liability for the previous tax year. Relief cannot be carried forward to a later year.

The shares must be held for a certain period or income tax relief will be
withdrawn. Generally, this is three years from the date the shares were
issued. But if the qualifying trade started after the shares were issued, the
period is three years from the date the trade actually started.

CAPITAL GAINS AND REFERRAL
This is available to individuals and trustees of certain trusts. A claim may be made to defer the assessment of any chargeable gain, or any part of such a gain, which arises within the period of three years before or one year after the issue of eligible shares in a qualifying company. The gain, up to the amount subscribed for those shares, may be deferred until the shares are disposed of or, if earlier, until certain other events occur.

There are no minimum or maximum amounts for deferral. And it does not
matter whether the investor is connected with the company or not.
Unconnected investors may claim both income tax and CG deferral relief.

LOSS RELIEF
If the shares are disposed of at a loss, you can elect that the amount of the
loss, less any income tax relief given, can be set against income of the year in which they were disposed of, or any income of the previous year, instead of being set off against any capital gains.

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THE INVESTMENT PROCESS
The subscription for the shares must be fully paid, in cash, at the time the shares are issued. The shares, and all other shares issued onthe same day, must be issued for the purpose of raising money for aqualifying business activity.

At least 80% of all money raised by the issue of shares on that date must be employed by the investeecompany for the purpose of a qualifying business activity within 12months, or within 12 months of the start of the trade, with another 12 months to employ the remaining 20% raised.

QUALIFYING BUSINESS ACTIVITY
A qualifying business activity must be a qualifying trade, or researchand development intended to result in a qualifying trade. It may be carried on either by the company or by a qualifying subsidiary, which is at least 90% owned, but the trade must be carried on wholly or mainly in the United Kingdom.

BASIC RULES - INCOME TAX RELIEF
Income tax relief can only be claimed by an individual eligible for relief. To be eligible an individual must not (with one exception,mentioned below) be connected with the company either before the sharesare issued or within three years of the issue of the shares (or of thecommencement of trade, if later).

An individual is, broadly, connected with a company:
if he or an associate of his is an employee, partner or paid director of the company, or if he and/or an associate possesses, or is entitled to acquire, more than 30% of the issued ordinary share capital, or loan capital and issued share capital, or voting power in the company. (This does not apply, subject to certain conditions, where the only shares owned are subscriber shares).
For this purpose an associate includes a husband or wife, line all ancestor or descendant, a business partner and certain persons withwhom the individual has connections through a trust.

A ‘paiddirector’ is one who receives, or is entitled to receive, any form of payment from the company other than certain items such as reimbursement of expenses allowable for tax purposes.

The exception referred to above is where at some time following the issue of the shares theindividual is connected with the company, and is so connected solely by virtue of being a director of the company who is so paid for services rendered as a director or employee, but was not so connected in any waybefore the issue. Subject to certain conditions, such an individual iseligible for relief.

QUALIFYING COMPANIES
The company must be an unquoted company at the time the shares are issued. That means it cannot be listed on the London Stock Exchange or any other recognised stock exchange. It can subsequently become a quoted company without the investors losing relief, but only if there were no arrangements for it to become quoted in existence when the shares were issued. For the EIS rules the Alternative Investment Market (AIM) and the PLUS Quoted and PLUS Traded Markets are not considered to be
recognised exchanges, so a company listed on those markets can raise
money under the EIS if it satisfies all the other conditions,

The qualifying company must not be controlled by another company (or another company and any person connected with that company). Nor must there be any arrangements in existence for it to be controlled by another company at the time the shares are issued. However, where a company needs, for commercial reasons, to put a new holding company above itself and;

a. all the shares in the old company are exchanged for shares of the
same kind in the new holding company; and
b. various other conditions, set out at VCM15200, are met,

the tax relief applicable to the old shares is effectively transferred to the
new shares.

The Company may have subsidiaries, but if it does they must all be qualifying subsidiaries – i.e. the company has more than 50% of the ordinary share capital of the subsidiary, and it is not controlled (by other means) by another company. (If the EIS company has a property management subsidiary that must be at least a 90% subsidiary.)

It must be a “small company”. The measure of whether a company is
“small” is the Gross Assets Test. The Gross Assets of the company – or
of the whole group if it is the parent of a group – cannot exceed £7million
immediately before any share issue and £8million immediately after that
issue. VCM15100 and Statement of Practice 2/06 explain how assets are
valued for the purpose of this test,

This company must have fewer than 50 full-time employees (or their equivalents) at the time the shares are issued.

It can be either a company carrying on the qualifying trade, or the parent
company of a trading group. The trade can be carried on either by the
company issuing the shares or a subsidiary, but if it is carried on by a
subsidiary, it must be at least a 90% subsidiary.

QUALIFYING TRADES
The trade must be conducted on a commercial basis and with a view to the realisation of profit. Most types of trades qualify, but the following are excluded:
• dealing in land, in commodities or futures in shares, securities or other
financial instruments
• dealing in goods, other than in an ordinary trade of retail or wholesale
distribution
• financial activities such as banking, insurance, money-lending, debt-
factoring, hire-purchase financing or any other financial activities
• leasing or letting assets on hire, except in the case of certain ship-
chartering activities
• receiving royalties or licence fees (though if these arise from the
exploitation of an intangible asset which the company itself has created,
that is not an excluded activity)
• providing legal or accountancy services
• property development
• farming or market gardening
• holding, managing or occupying woodlands, any other forestry activities or timber production
• operating or managing hotels or comparable establishments or managing
property used as an hotel or comparable establishment
• operating or managing nursing homes or residential care homes, or
managing property used as a nursing home or residential care home
• providing services to another person where that person’s trade consists, to a substantial extent, of excluded activities, and the person controlling that trade also controls the company providing the services.

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WITHDRAWAL OF RELIEFS
If any of the conditions relating to the company cease to be satisfied at any time beginning with the issue of shares and ending three years later, or three years from commencement of trade if this gives a longer period, the EIS income tax relief is withdrawn and /or the deferred gains come back into charge to tax, as the case may be.

Relief is also wholly or partially withdrawn and the deferred gains come back into charge if, within the three year period the claimant receives value from the company or otherwise ceases to be eligible for relief. In the case of Capital Gains Deferral Relief , the deferred gain comes back into charge on the disposal of the shares other than to a cohabiting spouse. Value is received from the company if , for example, it repurchases or redeems the shares, or makes the individual a loan or provides a benefit or facility to the individual. However in certain circumstances, ‘insignificant’ amounts of value (or the return of value to the company without delay) will be disregarded.

TAX INVOICE
The reliefs are not available unless the shares are subscribed for, and issued, for bona fide commercial purposes and not as part of a scheme of arrangement, the main purpose of which, or one of the main purposes of which, is the avoidance of tax. There must not be any arrangements that would either secure in advance a means of realising the shares or underpin their value.

HOW TO CLAIM
Investors make a formal claim for EIS Relief or EIS Deferral Relief from their inspector of taxes. The claim is made on receipt of Form EIS 3 from the company. Form EIS 3 is a certificate issued by a company, with the approval of the Inland Revenue, confirming that it is a qualifying company for these purposes.

A company cannot seek the Inland Revenues approval until it has carried on a qualifying activity for four months. The approval must be sought within two years of the end of the year of assessment in which the shares are issued or, if later, within two years of the period commencing with the date on which the company completed its first four months of trading.

An investor’s claim must be submitted to his tax inspector no later than the fifth anniversary of 31 January following the year of assessment in which the shares were issued (or treated as issued if relief is carried back). The Company proposes to submit its application to the Inland Revenue to issue EIS 3 as soon as it is practicable

To view the detailed ruling given out by the EISA, please click here.