Seed Enterprise Investment Scheme
An A-Z Guide to the New SEIS Tax Shelter
THE NEW Seed Enterprise Investment Scheme (‘SEIS’) may be the ‘best thing since sliced bread’ for some investors – but only if the slots in your toaster are exactly the right size!
I hope you’ll pardon the rather strained analogy. To put it another way, the SEIS offers fabulous tax-saving opportunities for investors but comes with a whole heap of conditions which, in practice, mean that its usefulness is extremely limited and its uptake may therefore turn out to be somewhat disappointing.
There are, in fact, some 55 pages of draft legislation which the people at the Treasury hope will prevent this incredibly generous scheme from being ‘abused’ by the tax avoidance industry and ensure that it is targeted purely at new start-up businesses as intended. Whether they will succeed in preventing such abuse remains to be seen, but they have certainly made it difficult for anyone else to understand the scheme, never mind actually use it!
But let’s start by looking on the bright side and considering the tax savings which are available under the scheme. At present (remember the legislation is still only draft), there appear to be four main benefits:
- Income Tax relief at 50% on the value of SEIS investments
- A CGT exemption for gains arising during 2012/13 which are reinvested in SEIS shares
- CGT exemption for gains on the SEIS shares themselves
- Income Tax relief for losses arising on SEIS shares
There is no arguing with the fact that this represents a fabulous range of tax reliefs for those who can navigate their way through the 55 pages of legislation to find an investment that actually qualifies!
Sadly, the scheme is very limited in scope and is hampered by several very restrictive limits.
Firstly, the individual investor can only claim relief on SEIS investments of up to a maximum of £100,000 per tax year.
Investments can, however, be carried back for relief in the previous tax year – although not back to 2011/12, unfortunately, as the scheme did not exist then. By 2013/14, however, it will be possible to make qualifying investments of up to £200,000 (with £100,000 carried back for relief in 2012/13) where no previous SEIS investments have been made.
The scheme only applies to shares issued between 6th April 2012 and 5th April 2017 (although it may be extended beyond 2017 if it proves successful).
Companies issuing SEIS shares are subject to a £150,000 limit on all state aid received in the preceding three years, including the value of the SEIS shares themselves. This effectively puts a limit of £150,000 on the amount of qualifying shares which a company can issue; which is further reduced if the company receives any state aid, such as a grant. For example, a company receiving a £10,000 start-up grant could only issue £140,000 worth of SEIS shares.
The company must also have total assets worth no more than £200,000 (before issuing the shares) and less than 25 employees (or full-time equivalents). It must also have been in business for no more than two years (and not carried on any other business previously). There are rules which allow a parent company with qualifying subsidiaries to issue SEIS shares, but the overall effect is much the same.
There are many more restrictions, and we’ll look at some more of them in a little while but, at this stage, it’s worth looking at how much an investor using the scheme might actually benefit.
To get the maximum benefit, you’ll need a capital gain, or gains, arising in 2012/13 of at least £110,600 which do not qualify for entrepreneurs’ relief and therefore attract CGT at 28%. The first £10,600 will be covered by your annual CGT exemption and the remaining £100,000 can be invested in qualifying SEIS shares, thus saving you £28,000 in CGT.
Secondly, you will also need taxable income of at least £142,185. Why? Because, for 2012/13, this level of income gives rise to an Income Tax bill of £50,000, meaning that you will be able to claim the maximum relief of 50% on a qualifying SEIS investment of £100,000. If you have less income, you will not be able to claim as much tax relief because the relief is effectively capped at the level of your total Income Tax bill.
(If some of your income is made up of dividends, you will need a higher overall level of income because dividends attract a lower rate of tax.)
So it takes income of at least £142,185 and capital gains of at least £110,600 in 2012/13 to get the maximum relief available this year: £78,000.
Of course, smaller investors can still get the maximum rate of relief, 78%, as long as they have sufficient taxable gains and income to cover their investment.
Let’s say you are able to invest the £100,000 maximum and get 78% relief: that means your investment has effectively cost you just £22,000. If the SEIS company succeeds and grows you may later be able to sell your investment at a profit (as long as you wait at least three years – see below). That profit will be a tax-free capital gain, meaning that the overall potential rate of return on your investment is greatly enhanced.
For example, if your investment grows by just 10% (to £110,000), you will have increased your money five-fold (5 x £22,000 = £110,000). That’s equivalent to a pre-tax return of 556% on a conventional stock market investment of £22,000.
If your SEIS investment doubles in value, you could get £200,000 back on a net layout of just £22,000 - equivalent to a pre-tax return of 1,124% on a conventional stock market investment!
The restrictions on the SEIS mean that it represents an extremely risky investment. Money has to be put into a small company, which the investor cannot control, carrying out a new business which fits the stringent qualification requirements. So, whilst the potential for rewards like the four figure returns considered above does exist, the likelihood remains that many investors could lose their money.
However, at present, it appears that these losses may not be as bad as they may at first appear: in fact, the SEIS may even turn a loss into a profit!
As we know, the investment attracts up to 50% Income Tax relief at the outset. If the investor loses their money, they can also claim Income Tax relief for the other 50%. This could provide total tax relief of up to 103%!
Penny has annual income well in excess of £200,000 and makes capital gains of more than £110,600 in 2012/13.
She invests £100,000 in qualifying SEIS shares, giving her Income Tax relief of £50,000 and CGT savings of £28,000.
Sadly, the company which issued the SEIS shares is a commercial disaster and is wound up before 5th April 2013 with no proceeds available to the shareholders.
Penny has lost her entire investment. She can, however, claim Income Tax relief for a loss of £50,000 – i.e. her investment of £100,000 less the Income Tax relief of £50,000 which she has already received on the investment. This loss is relieved at her marginal tax rate of 50%, giving her a further saving of £25,000.
So whilst, on a commercial level, Penny has just lost £100,000, she has received a total of £103,000 in tax relief (£50,000 + £28,000 + £25,000). Her disastrous pre-tax loss of £100,000 has yielded an after tax profit of £3,000!
Where the SEIS company folds after 5th April 2013, the total tax savings for someone like Penny would be £100,500 - the reduction being due to the fall in the ‘super tax’ rate (on income over £150,000) from 50% to 45%. Nonetheless, this would still represent an after tax profit on the most disastrous of investments!
For other higher rate taxpayers, with income below £150,000, the maximum overall tax saving on a failed SEIS investment is 98% (50% on investment + 28% CGT saving + 40% of the remaining 50% on ‘failure’). This does still leave an overall after tax loss, but the amount at stake is just 2%. Many would consider this worth the risk!
SEIS investments are subject to many restrictions. Here we will look at some of the most important ones.
Generally speaking, the investor cannot dispose of the SEIS shares within three years of the date of issue. There are two important exceptions to this, however:
- Shares can be transferred to the investor’s spouse or civil partner
- The rule does not apply if the company is put into non-voluntary administration and subsequently wound up (i.e. in the case of a corporate failure)
The investor and their ‘associates’ (see below) cannot be employees of the company, but can be unpaid directors.
The investor, together with their ‘associates’, must not have a ‘substantial interest’ in the company: this means that they cannot have more than 30% of the ordinary shares, total share capital, voting power, or rights to assets on a winding up; or otherwise have control of the company.
The SEIS company must either carry on a qualifying trade or be engaged in research and development activities which will lead to, or benefit, a qualifying trade. Furthermore, it has to be a new trade which has either not started yet, or which the company has started within the last two years. Qualifying trades are the same as under the existing Enterprise Investment Scheme and are subject to many exclusions; including most property-based businesses (even hotels and other businesses offering overnight accommodation), and professions such as accountants and lawyers.
No relief is given until the company has either been trading for four months or has spent at least 70% of the money raised for the purpose of a qualifying trade.
Shares must be subscribed for (i.e. issued directly to the investor by the company) wholly in exchange for cash, fully paid up at the time of issue, and must have no preferential rights to assets on a winding up, no redemption rights and no cumulative dividend rights. Some preferential dividend rights are allowed, but must be non-discretionary.
For the purposes of the SEIS, ‘associates’ include: the investor’s spouse, civil partner, parents, grandparents, etc., children, grandchildren, etc., trusts set up by the investor or any of these relatives, and business partners of the investor.
So, in effect, you can’t use the SEIS to invest in your spouse or children’s company.
But there are still plenty of people who are not classed as ‘associates’: including unmarried, common-law life partners, step-children, siblings, aunts and uncles, nephews and nieces and your in-laws – leaving plenty of scope to invest in other family members’ businesses using the SEIS if you so wish, and can meet all the other qualifying rules!
In fact, it only takes four ‘unconnected’ people to set up a SEIS company and get the full range of benefits discussed above. That could be four friends, two unmarried couples, four brothers and sisters, two friends and their unrelated step-children, or many other combinations. You just need to find three other like-minded people.