EIS funding down 20% due to complex tax rules for SMEs

A sharp fall in the use of funding tax breaks offered by schemes like the Enterprise Investment Scheme (EIS) and Seed Entreprise Investment Scheme (SEIS) has seen a 20% decline in applications from start-ups and SMEs over the last 12 months due to the complexity of the rules

HMRC’s analysis suggests that the number of new applications is dropping sharply because of changes to the rules, which are now too confusing as the UK tax code becomes increasingly complex.

Over 3,000 companies used £1.6m of EIS tax relief in 2015-16, down from £1.9m of funding used in 2014-15 when 3,330 companies accessed the EIS/SEIS system.

The figures indicate that the 1,500 companies use the tax relief for the first time under the scheme raised a total of £787m, down on the amount raised by 1,710 companies claiming for the first time in 2014-15 (£1,080m).

The number of companies raising funds in 2015-16 was 3,285, close to the peak of 3,315 companies in 2000-01 (which reflects the dot com boom in 2000), demonstrating the failure of the policy to reach the SME sector.

HMRC analysis admits the policy changes made in Summer Budget 2015 may have dampened interest in EIS.

For only the second time since the introduction of the scheme the number of companies raising funds for the first time in 2015-16 was lower than the number of existing companies, with only 48% of companies raising funds for first time.

Ray Abercromby, partner in business tax at Smith & Williamson, said: ‘We are seeing the changes at the Summer Budget 2015 take effect.  The alterations themselves weren’t too hard hitting but the constant tinkering with these government-backed tax schemes is causing uncertainty for small businesses and investors alike.

‘Businesses and investors now have to pay very close attention to the structure of their businesses.  The changes have forced individuals, who just want to get on and grow their business, to focus on the structure of the business in case they accidently fall foul of the rules. 

‘At first glance, the changes appeared to discourage investment in the UK’s small and scale-up businesses, the lifeblood of our economy, and these statistics indicate that could be the case.’

The EIS was introduced in 1994 to help smaller, higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new full-risk ordinary shares in those companies.

Subject to trading and timing requirements, EIS allows a 30% income tax relief, set off against income, one year carry back of the income tax relief, as well as a capital gains tax exemption on the disposal of shares (if sold after a qualifying three year period).  Existing gains can also be deferred by rolling it into the EIS investment. However, the rules and structures surrounding the use of, and claiming of, the relief have become increasingly complicated in recent years.

 The Finance Act (No 2) 2015 introduced significant changes to the EIS rules, which took effect for shares issued on or after 18 November 2015. Most of the rule changes emanate from the EU as part of its continued review of EIS and the other venture capital schemes as part of the state aid provisions.

Abercromby said: ‘Post-Brexit, the government may choose to look at the relief associated with EIS/SEIS and return to pre-2015 levels.  It has proved to be very popular, and beneficial to the economy as a whole, and could be a way of encouraging UK small business growth.’

HMRC’s report, Enterprise Investment Scheme and Seed Enterprise Investment Scheme April 2017 Statistics on Companies raising funds, is here: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/611200/April_2017_Commentary_EIS_SEIS_Official_Statistics_v5.pdf

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