EIS – beware of growth shares

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EIS is a generous tax relief for those subscribing for ordinary shares in a qualifying company. The investor broadly receives an income tax credit equal to 30% of the amount invested. Thus on an investment of £100,000 an investor will receive an income tax credit of £30,000. There are also Capital Gains Tax (“CGT”) reliefs available for EIS investments.

Needless to say there are a large number of complex conditions that need to be met both by the Company and the investor for a subscription of shares to qualify for EIS. Most of these conditions need to be met for a period of three years from the date of the investment or the relief is clawed back. One of these conditions is that the EIS investment cannot be in a class of shares that has preferential rights over another class of shares with respect to dividends, redemption or assets on winding up.

An entrepreneurial business looking to raise finance under EIS will also often be looking to incentivise key employees through a share incentive scheme. The problem with simply issuing the employees with shares is that they need to pay market value for their shares or an income tax charge (and possibly national insurance) will arise on the difference between the market value and the amount paid for the shares.

One possible solution to this is to use growth shares. These are shares that do not receive capital value until a hurdle is reached. Let us say, Grace Limited is currently valued at £1 million. Grace Limited then issues shares that do not receive any consideration, when the Company is sold, unless the proceeds exceed £1.2 million and even then they only share in any excess. As such, a case can usually be made that on issue the growth shares have nominal value. Thus they can be issued to employees with a minimal, if any, income tax charge.

I now come to a recent case heard before the First-Tier Tribunal (“FTT”), Abingdon Health Limited [2016] TC 05525. In 2012, 2013 and 2014 Abingdon Health Limited (“Abingdon”) issued shares to third-party investors under EIS. In 2013 Abingdon issued growth shares to its key employees. The growth shares only participated in distributions on winding-up or other return of capital over and above the hurdle amount. In the view of HMRC, and unfortunately the FTT, this meant that the ordinary shares issued under EIS had a preferential right over the new class of shares i.e. the growth shares. As such the ordinary shares ceased to qualify for the EIS relief and the EIS relief already claimed was clawed back.

This just shows how careful one needs to be to preserve EIS relief, not just at the time of the share issue but in the subsequent period. Professional advice should always be sought.

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