EIS has many legislative requirements, all of which must be satisfied for the company to be entitled to issue the subscribers with form EIS3.
EIS relief applies to income tax and EIS deferral relief applies to CGT. There are some differences between the EIS income tax rules and CGT EIS deferral relief. In particular the 30% ceiling on an investor’s shareholding does not apply for EIS deferral relief.
EIS deferral relief was denied for a share subscription in the recent case of Harvey’s Jersey Cream Ltd because the shares were not issued to raise funds for the purpose of a qualifying business activity (this requirement in TCGA sch 5B para 1(2)(g) also applies to EIS income tax relief, see ITA 2007 s174, thus the decision is relevant to EIS, SEIS and EISDR).
In summary, the facts were:
- a partnership had five partners: father, his three adult children and a company which had a 5% participation in the partnership profits. The shareholders in the company were the four individuals;
- the four individual partners took drawings of £1.25m in aggregate from the partnership;
- the four individuals used this to subscribe for shares in the company;
- the company put the £1.25m into the partnership resulting in its profit share increasing to 60%, in other words, the money went round in a circle.
The First Tier Tribunal (FTT) held that the monies raised by the issue of shares were not employed for the purpose of the trade carried on by the company. Arguments that the greater share of partnership profits enabled the company to qualify as the cash was used to acquire a greater interest in the partnership’s assets were rejected on the basis that getting a greater share of a trade is not an activity of the trade. As regards the monies raised, the FTT concluded ‘there was no evidence that they were used for anything other than to pay for changing the partners’ interests in the partnership’. Also, ‘there was no evidence that the monies were raised with the intention that the money would be employed in the activities of the trade’ and ‘all the evidence showed that the monies were intended to be employed in giving the money to the other partners’.
Finally, however, the tribunal did mention that there were some circumstances where its findings could have been different such that the funds would have been used in activities of the trade. These were:
- if the monies had been used to pay off an overdraft incurred many years ago when a partner had withdrawn funding; or
if the monies had been used to buy new assets, whose later sale happened to finance the retirement of a partner.