SEIS and EIS
As a result of the rising success of the British film industry, investing in British film through an Enterprise Investment Scheme offers investors a rewarding and tax efficient investment proposition due to the generous tax benefits available.
Tax relief opportunities exist to encourage investment in start-up and early-stage film companies.
BristowHouse Productions is working with London City based SEEDeis platform and Hampshire based Independent Financial Solutions . The tax reliefs in question are the relatively new Seed Enterprise Investment Scheme (SEIS) for investment in film development companies and the long-established Enterprise Investment Scheme (EIS), which is available to small and medium-sized companies, whether or not at the start-up stage. More details of these schemes are provided in our earlier Keynote “EIS and SEIS Quick Guide”.
Investing in BristowHouse is an opportunity to take advantage of the tax reliefs offered for SEIS investment.
At present BristowHouse is involved in producing Used Books a classic British romantic comedy for cinema. While production on Used Books is in progress, BristowHouse is also developing 11 more projects including 2 horror movies, one set in Ireland and the other set in Venice. For TV development: a true spy story about MI6 during world war II as well as the story of an international drug smuggling cartel based in Californian.
Income tax relief for the amount subscribed for the issue of new shares by the company:
- SEIS: 50% relief, subject to £100,000 annual limit on investment per investor, and overall limit of £150,000 per company.
- EIS: 30% relief, subject to £1m annual limit on investment per investor.
Capital gains tax exemption on sale by an investor of shares in the company under SEIS and EIS if the investment qualified for income tax relief.
Capital gains tax relief on other gains:
- SEIS: Up to £50,000 of gains realised by an investor on the disposal of any other asset in 2013/14 can be exempt from CGT if reinvested in a SEIS investment.
- EIS: Gains realised on the disposal of other assets which are reinvested in EIS shares in the period starting one year before and ending three years after the disposal in question can be rolled over; i.e. the tax liability on the gain is deferred until the EIS shares are sold.
Income tax relief on losses: Further income tax relief can be available if the investment is lost (i.e. if the business fails), thereby further reducing the after-tax risks to the investor.
With this brief introduction to the potential tax benefits of SEIS and EIS investments, here are some examples of traps for the unwary:
The emergency temporary funding trap
A company has agreed terms in principle for a SEIS or EIS funding but negotiations on detailed terms will take a little longer to conclude. The company is in urgent need of some funds to pay current bills and one of the prospective investors offers to make a short-term loan of £30,000 to the company to tide it over until the funding is completed. The amount lent will then be converted into the shares to be acquired by this investor when the funding completes.
However, if the loan is capitalised into shares, the investor will not secure SEIS or EIS relief. The rules require that the shares are subscribed for in cash.
Instead, it is suggested that the loan be repaid and the amount repaid be immediately applied by way of subscription in cash for the shares. This addresses the above problem, but unfortunately there are rules which deny relief to the extent that the investor receives value (as defined in the legislation) from the company within a prescribed period. A repayment of the loan in these circumstances would constitute value received.
This is a difficult area and an example of how the tax rules seem to work against what is a perfectly understandable commercial arrangement. In practice, the best approach is to avoid loans from prospective SEIS or EIS investors and try to secure any such temporary funding from another source (perhaps an investor who is otherwise ineligible for SEIS or EIS relief).
The combined SEIS/EIS funding trap
An approach we have seen adopted by start-up companies since SEIS relief was introduced nearly 18 months ago is for the company to seek to secure first-round funding of an amount greater than the aggregate £150,000 SEIS limit (e.g. a total funding of £1.5m) and to look to provide SEIS relief to the investors (as a group) for the first £150,000 of funding and EIS relief for the balance. For reasons of costs and the practicalities of implementation of the funding, the aim is to have a single set of documentation governing the total £1.5m funding and to receive that total in one sum on a single completion. The company does not want to receive £150,000 initially and then have to approach the investors a second time, some weeks or months later when the SEIS money has been spent, to request a transfer of the balance of the funding.
The problem with this is that the EIS rules prevent EIS relief where there has been a SEIS funding unless at least 70% of the amount raised by way of SEIS funding has first been spent on qualifying purposes. As explained above, this problem cannot be solved by the EIS money initially being lent to the company. Another approach has to be identified.
One solution is for a single subscription agreement to be signed by investors governing the terms of the total £1.5m funding. This will provide for the SEIS shares to be issued upon signing of the agreement. It will also provide for the EIS shares to be issued subject to the 70% requirement mentioned above first having been satisfied. The subscription agreement will provide for the money for the EIS issue to be provided by the investors at completion of the SEIS issue upon terms which provide for it to be paid into a solicitor’s client account, to be held to the order of the investors. The terms of the documentation provide authority from the investors for the money in the solicitor’s account to be released to the company by way of subscription for the EIS shares only when the 70% requirement is satisfied. A director of the company will certify when the condition is satisfied and the solicitors will provide an undertaking to confirm that the money will be released to the company when this certification is provided. The company will also be obliged to issue the EIS shares when the certification is provided. With care being taken in respect of the implementation of these arrangements, the main aims of the company are secured in a SEIS/EIS compliant way.
Some SEIS founder shareholder traps
In cases where a founder shareholder will own no more than 30% of a start-up company’s share capital after a SEIS fund raising, SEIS relief is potentially available to the founder. A typical case may involve two founders who set up a company with one share each, paying £1 for each share. This is then followed by a SEIS funding from friends and family, with the founders putting in money as part of this funding. Following the funding, the founders’ percentage interest in the company’s share capital is diluted to no more than 30% each and so it would appear that they can satisfy the SEIS requirement that they hold no more than 30% of the share capital.
One trap arises from the fact that this 30% restriction applies in the period starting with incorporation of the company and ending three years after the issue of the SEIS shares. So holding a 50% interest in the period preceding the SEIS issue precludes the founder from claiming SEIS relief on his subsequent investment. This problem can be avoided if during the period preceding the SEIS issue, the company does not trade or make preparations for carrying on its business, but this will often not be possible. So it may be better to consider whether it is possible to have a greater number of individuals (who are not “connected” in tax terms) involved at the stage of formation of the company such that none has more than 30%.
Another point to note is that SEIS will not be available if, in the same period, the investor is an employee without also being a director. So, typically, any founder who may be looking for SEIS relief should be appointed as a director from the outset.
If such problems are circumvented, it should also be appreciated that the share issued to the founder on formation of the company is unlikely to eligible for SEIS relief. This is of no consequence in terms of income tax relief, in view of the tiny amount paid for that share. However, if that share comes to represent more than a minimal amount of the founder’s total post-SEIS funding shareholding, this will have an impact on the extent to which a sale of the total shareholding at a future date can benefit from the CGT exemption. This problem can be addressed by ensuring that the initial share issued on formation is diluted to an insignificant proportion of the founder’s shareholding after the SEIS funding; i.e. by careful management from an early stage of the number and denomination (e.g. use of shares of 1p each on company formation) of shares to be issued.