Kevin Read discusses some recent cases that show how the valuable tax reliefs available under the enterprise investment scheme can be lost in seemingly innocuous situations.
The enterprise investment scheme (EIS) and its sister scheme, seed EIS (SEIS), provide very generous tax breaks, which significantly reduce the effective cost of investing in high-risk, unquoted trading companies.
To get these tax breaks (which are not discussed in detail here), a plethora of detailed conditions must be met, by both the company and the investor. Unfortunately, various cases in recent years have resulted in investors not getting the relief to which they believed they were entitled.
Ames v HMRC [2018] UKUT 0190 TCC
Mr Ames had made an investment into an EIS qualifying company but, having negligible income of £42 for the year, had not claimed income tax relief at the time. When he sold the shares, he assumed that the gain was exempt from capital gains tax (CGT). HMRC said that the exemption is only available where a claim has been made for income tax relief and refused to allow a late claim.
At the First-tier Tribunal (FTT), the judgment was that only a literal interpretation could be applied to the legislation, so a valid income tax claim had to have been made if an investor is to get CGT exemption.
Mr Ames appealed to the Upper Tribunal, which agreed with the FTT that the CGT exemption only applied where there had been a claim for income tax relief. However, the Upper Tribunal also provided judicial review of HMRC’s decision-making process and concluded that it had been flawed when deciding whether to allow a late claim. HMRC's decision to refuse the taxpayer's late claim was therefore remitted back to HMRC for re-consideration.
Innovate Commissioning Services Ltd v HMRC [2017] UKFTT 741 (TC)
The company (ICSL) sought advance assurance from HMRC in connection with a SEIS share issue. HMRC said it would authorise the issuance of compliance certificates when it received form SEIS1. The company, however, submitted an EIS1 form (i.e. a form used for EIS relief purposes) instead.
HMRC confirmed receipt but wrote to the company to check that it had intended to submit the EIS1. Unfortunately, the company had moved address, so it did not receive the letter. In September 2015, HMRC gave authority for the company to issue compliance certificates for the EIS.
In April 2016, realising that it had submitted the wrong form, the company submitted an SEIS1 and asked that the EIS1 be withdrawn. HMRC refused.
The case was similar to X-Wind Power Limited v HMRC [2017] UKUT 0290 (TCC) and GDR Food Technology Ltd v HMRC [2016] UKFTT 466 (TC), which had been lost by the appellants. ICSL said there were differences because it had sought advance assurance from HMRC, which was therefore aware that it had the intention to make a SEIS issue.
The FTT’s decision was that once granted, HMRC had no power to withdraw the original application and replace it with another. The taxpayer's appeal was dismissed; its investors therefore missing out on the more generous income tax relief of the SEIS.
Flix Innovations Ltd v HMRC [2016] UKUT 301
The EIS legislation (in ITA 2007, s173(2)(aa)) states that shares issued under the EIS scheme should not, at any time in the required holding period, carry any present or future preferential right to the company’s assets on a winding-up.
Flix Innovation Ltd.’s (FIL’s) share capital had been reorganised to convert some of that held by the two founder shareholders into deferred shares, which
ranked after the ordinary shares for repayment of share capital on a winding-up; and had no rights to share in any surplus.
HMRC refused to issue EIS compliance certificates in respect of the ordinary shares due to the presence of the deferred shares. Having argued for a purposive interpretation of s 173(2)(aa) and lost at the FTT, FIL appealed to the Upper Tribunal. However, the latter dismissed the appeal, saying that Parliament had clearly legislated that any preferential right debarred relief.
Practical Tip:
The lesson is that, when dealing with these valuable venture capital tax reliefs, ‘the devil is in the detail’.
