Budget 2011: Boost for investment in small companies

April 2011

The 2011 budget which was announced on 23 March 2011 introduced reforms to the Enterprise Investment Scheme (EIS), which are expected to take effect partly in April 2011 and partly in April 2012.

EIS schemes are popular with small companies as a means of raising finance from private investors. The tax incentives available to investors encourage them to fund small companies which are usually considered more risky than larger publicly traded companies. The tax savings from EIS are intended to help to off-set this risk and encourage small company growth. From the company's point of view, EIS allows it to raise funds for business development by issuing shares in the company to investors rather than borrowing from a bank, which is cheaper in the short term.

Qualifying companies and feed-in tariffs

For a company to qualify it must carry on a qualifying trade. This extends to almost anything, but excludes companies engaged in some activities, including: hotels, care homes, property development, farming, dealing in securities, receiving royalties or licence fees, mining, shipbuilding, coal, steel, leasing or hire, and professional firms such as solicitor's practices.

The budget has now extended this list to exclude any scheme which attempts to profit from the electricity feed-in tariff scheme. This appears to be in response to the explosion in the number of solar and wind energy schemes funded by EIS and set up for the purpose of profiting from the generous government subsidies available. It was also felt that these types of business did not conform to the risk profile of small businesses that EIS was intended to address, in that the government subsidy available means that these companies are inherently less risky. This will not affect schemes already underway but will disrupt plans for future schemes already in the pipeline.

To qualify for EIS there is a requirement that the company is a "small company". Currently this means that among other things it must not have gross assets in excess of £7 million before the EIS share issue or £8 million after, and it must have fewer than 50 full-time employees. With effect from April 2012 this definition will be extended to fewer than 250 employees and gross assets of £15 million before issue. It does not appear that any limit on gross assets post issue will be imposed.

Publicly quoted companies

Companies which are publicly quoted may not raise money under EIS, however this does not extend to companies admitted to trading on AIM and PLUS markets. Previously, the small company definition made it unlikely that such a company would be small enough to qualify for EIS. However under the new rules planned for April 2012, it is likely that more AIM and PLUS companies will be able to take advantage of EIS.

From an investor's point of view this is likely to be particularly attractive, as one of the major issues facing investors in EIS companies is that there is usually no ready market for EIS shares. An EIS qualifying company trading on AIM will provide a mechanism for investors to realise their investment once they have held their shares for at least three years.

Currently companies are not permitted to raise more than £2 million in a single 12 month period under EIS. This will be increased to £10 million in April 2012 and again this will be of interest to smaller companies admitted to trading on AIM and PLUS.

Tax incentives extended

The incentives for investors in EIS qualifying companies are as follows:

• The maximum amount that a single investor can invest per year in EIS qualifying companies will increase from £500,000 to £1 million with effect from April 2012. This is a significant increase and will no doubt create a larger pool of potential EIS investment cash for small companies to tap;
• The main EIS tax relief is the ability to set off up to 20 per cent of the amount invested against the investor's income tax bill for the year. On an investment of £500,000 under the rules this allowed a maximum set off amount of £100,000. In April 2011 EIS income tax relief is set to increase to 30 per cent of the amount invested. As such it is anticipated that by April 2012 an investor could set off up to £300,000 if £1 million is invested;
• Any gain realised on the sale of EIS shares is free from capital gains tax, assuming they have been held for more than three years. This position will not change under the new Budget;
• If a loss is realised on the sale of an EIS share it can be set against the investor's income for the year in which they were sold. This position will not change under the new Budget;
• Capital gains realised on the sale of an asset can be deferred by investing the gains in an EIS qualifying company. The gain can arise from the disposal of any kind of asset, but the investment must be made within the period one year before or three years after the gain arose. There are no minimum or maximum amounts for deferral and no minimum period for which the shares must be held. The deferred capital gain is brought back into charge whenever the shares are disposed of. This position will not change under the new Budget;
• Shares in unquoted companies, which include those admitted to trading on AIM and PLUS, which have been held for a minimum of two years will continue to be exempt from inheritance tax under the business property relief regime. As such EIS will continue to play an important part in estate planning.

Summary

In summary, EIS remains attractive to investors who are looking for a tax efficient investment and will become more attractive to those investors who have a priority to reduce their income tax liability.

The increase in the amount which can be raised and the extension of the definition of "small companies" means that EIS will now become a viable fundraising model for much larger companies than ever before. It is also likely that small companies trading on AIM and PLUS will develop more of an interest in EIS.

All of the above changes to EIS are subject to state aid approval from the EU, but it seems likely that this will be obtained without significant difficulty. This article will be updated once the requisite approvals have been received.

TLT has considerable experience in advising EIS qualifying companies on their fundraisings and is a member of the Enterprise Investment Scheme Association. TLT has also advised on the structuring and subsequent investments of EIS funds.

The changes to EIS are set out on page 52 of Chapter 2 of the Budget 2011 which is available under Related links.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at April 2011. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

TLT LLP is a limited liability partnership registered in England & Wales number OC 308658 whose registered office is at One Redcliff Street, Bristol BS1 6TP England. A list of members (all of whom are solicitors or lawyers) can be inspected by visiting the People section of this website. TLT LLP is authorised and regulated by the Solicitors Regulation Authority under number 406297.

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