Investment

SEIS and EIS Tax-Efficient Investing: A Detailed Introduction

Startup investing is an emerging asset class that is high-risk high-reward. It is also an asset class that attracts significant tax breaks. In this article I outline the 3 primary tax breaks available to UK investors.

But first, why does the government care about this sector anyway?

Entrepreneurs and startup founders are usually taking a high risk shot to solve a problem and scale, usually with some proprietary technology or solution, which then leads to massive growth and disruption in a market if they succeed.

The world of venture capital and startup investing is fascinating as much as it is vital for our progress as a community, country and species – which is why the government incentivises it heavily with tax relief schemes.

Tax reliefs are the tool of choice since it stimulates investment into an asset class that may otherwise appear too risky. Tax relief is also particularly appealing in the UK since taxes in the UK are at a historical high.

Venture capital schemes for startups

There are three main venture capital schemes under HMRC which offer private investors tax benefits specifically for investing in early startups or medium stage startups.

Venture Capital Trusts (VCTs) are companies you can invest in that act like funds and invest your money in a range of unlisted early startups and medium stage startups. You essentially invest in a basket of startups and receive tax relief for doing so, you can read more about that here.

The other two schemes are the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS), for startups and medium sized startups respectively.

From an investor’s perspective, SEIS and EIS give significant income tax relief, capital gains tax (CGT) relief and inheritance tax relief.

From a startup’s perspective, SEIS and EIS offer potential investors an extra incentive to invest in your company, making it easier to find that much-needed capital.

What types of companies are eligible for SEIS and EIS?

As we’ve discussed elsehwere, not every new small business is a startup. Some form of innovation and growth is necessary to be considered a startup, which is why a newly founded company must partake in a ‘qualifying’ trade to be eligible for SEIS or EIS investments.

Thankfully, most trades do qualify, even if your startup is in its research and development phase towards a qualifying trade.

The funds raised must also be for a qualifying business activity, which is largely for the growth of your company such as in hiring new staff, product development, or marketing.

The government mandates that a company with 20+% of its activity in a non-qualifying trade cannot raise investor money under SEIS or EIS.

‘Non-qualifying trades’ include traditional trades, such as farming, legal or financial services, running a hotel, coal and steel production, or generating energy. Typically, the key characteristic of a startup on the other hand is the development of proprietary technology or some kind of innovation.

SEIS: Seed Enterprise Investment Scheme

SEIS rules for companies

  • Your company must not have been trading for more than 2 years.
  • You must have fewer than 25 full-time employees in your company.
  • Your company cannot have gross assets of more than £200,000 at the time the shares were issued.
  • Your company can receive a maximum of £150,000 of SEIS investments in its lifetime.
  • Your company cannot have received investment through VCTs or EIS (but it can do after SEIS is exhausted).

The investment your company receives from SEIS must be spent within 3 years of the share issue, and you must spend it on a qualifying trade, preparation to carry out a qualifying trade, or research and development that’s expected to lead to a qualifying trade.

Check out the government website for more on how to apply for SEIS investment and whether your company is eligible.

SEIS benefits for investors

Income tax relief

You can claim up to 50% of the value of your investment in a SEIS eligible company in the form of income tax relief. The maximum annual investment you can claim tax relief on is £100,000.

So, for example, if you invested £5,000, you can save £2,500 in income tax.

Capital gains tax relief

Selling your shares after holding them for at least 3 years results in capital gains tax relief. So, for example, if you initially invested £5,000 and the value of your investment increased to £20,000 after 3 years, you will not pay any capital gains tax on the £15,000 gain should you decide to sell your shares.

Capital gains tax reinvestment relief

If you sell any non-SEIS asset and invest those funds in a SEIS eligible company, you will receive 50% capital gains tax relief on the original investment, up to £100,000, with a maximum relief of £50,000.

Loss relief

If the SEIS eligible company you invest in fails and your investment is worth nothing, or you sell your shares at a loss, you can claim loss relief.

This loss relief is equivalent to the rate at which you pay income tax. So a higher rate taxpayer who pays 40% income tax can claim 40% of the net loss in loss relief.

To illustrate, if you made a £20,000 investment and the business goes broke and your investment is worth nothing, you can claim loss relief. You would firstly claim 50% of your investment in income tax relief, which is £10,000. You would then claim 40% loss relief on the remaining £10,000, which is £4,000.

All this means your overall loss on a £20,000 investment is £6,000. Without SEIS it would have been the full £20,000.

Inheritance tax relief

There will be no inheritance tax on the value of the shares of a SEIS eligible company on the condition of having held them for at least 2 years.

SEIS rules for investors

All these perks come with the following rules:

  • You must be a UK taxpayer.
  • In a single tax year, you can only invest up to a maximum of £100,000 in any number of eligible companies.
  • As mentioned above, you must hold your shares for at least 3 years before selling or gifting them otherwise the relief will not apply.

EIS: Enterprise Investment Scheme

EIS rules for companies

  • Your company can raise up to £5 million in any given year (anything raised above this will not be EIS eligible).
  • Your company can raise a maximum of £12 million in its lifetime under EIS (or any other venture capital scheme).
  • Your company cannot have gross assets of more than £15 million, and not £16 million immediately afterwards.
  • You must have fewer than 250 full-time employees in your company.
  • Your company must not have been trading for more than 7 years.

The investment you receive under EIS must be spent within 2 years of the share issue to grow or develop your business. The money raised must also pose a risk of loss to capital for the investor, reminiscent of a risk-sharing Mudaraba model.

Check out the government website for more on how to apply and whether your company is EIS eligible.

EIS benefits for investors

Income tax relief

You can claim up to 30% of the value of your investment in an EIS eligible company in the form of income tax relief. The maximum annual investment you can claim tax relief on is £1 million. So, for example, if you invested £50,000 you can save £15,000 in income tax.

Capital gains tax relief

Selling your shares after holding them for at least 3 years results in capital gains tax relief. So, for example, if you initially invested £50,000 and the value of your investment increased to £150,000 after 3 years, you will not pay any capital gains tax on the £100,000 gain should you decide to sell your shares.

Capital gains tax deferral relief

If you sell any non-EIS asset and invest those funds in an EIS eligible company, you will not have to immediately pay capital gains tax. You will pay capital gains tax when you sell those EIS eligible company shares.

Loss relief

Just as with SEIS, if the EIS eligible company you invest in fails and your investment is worth nothing, or you sell your shares at a loss, you can claim loss relief.

This loss relief is equivalent to the rate at which you pay income tax. So a higher rate taxpayer who pays 40% income tax can claim 40% of the net loss in loss relief.

As an example, if you invested £50,000 and the business fails and your investment is worth nothing, you can claim loss relief.

You would firstly claim 30% of your investment in income tax relief, which is £15,000. You would then claim 40% loss relief on the remaining £35,000, which is £14,000. Which means your overall loss on a £50,000 investment is just £21,000.

Inheritance tax relief

There will be no inheritance tax on the value of the shares of an EIS eligible company on the condition of having held them for at least 2 years.

EIS rules for investors

These benefits come with the following rules:

  • You must be a UK taxpayer.
  • In a single tax year, you can only invest up to a maximum of £1 million in any number of eligible companies.
  • You must hold your shares for at least 3 years before selling or gifting them in order to qualify for the relief.

Conclusion

It is imperative for the development of the economy that we invest in innovative startups. It is also of paramount importance that as Muslims we support startups founded by Muslims.

Investments in sharia-compliant startups made with the right intention can not only increase your wealth, but you can contribute to the overall good of society and play your part.

 

Author: Mohammed Ayaaz Adam. A Politics, Philosophy, and Economics graduate working in the finance industry and a CFA candidate. A graduate of the Alimiyyah degree with an interest in Islamic Law, Legal Theory, and Islamic Finance. You can connect with him on Twitter here.

 

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