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Enterprise Investment Schemes (EIS) offer valuable tax reliefs for UK income tax payers who subscribe for shares.  Provided the qualifying criteria for the investor, the company and the trading activity are met for the requisite period of time, significant tax savings can be achieved for qualifying investors.  As a recent case has shown, changing the structure of the company could reverse beneficial tax treatment.

Enterprise Investment Schemes have been in existence (in various guises) since 1983.  They provide a strong tax incentive from the Government to encourage individuals to invest in small unquoted trading companies.

Because of the technical detail of the reliefs, close liaison with HMRC is required.  A clearance application is usual and adherence to the conditions is essential.

One of the characteristics of qualifying shares is that they must be ordinary shares and not have preferential rights.  A recent case has highlighted a trap that voided EIS treatment given more than two years previously.

A qualifying company sought relief for three rounds of subscription for shares.  HMRC accepted the company’s application for EIS relief in respect of rounds one and two.  The company traded well for years.

Between the second and third subscription, the company amended its articles to reflect a new class of shares issued to certain key employees.  The changes included a preference on a liquidation so that the holders of the EIS shares received a return of assets in priority to those shares held by the few key employees.

A clearance was applied for in respect of the third round.  HMRC’s response disappointed the company.   Because of the introduction of the preference arrangements, the application for relief in respect of the third round was refused.

The response was doubly disappointing.  HMRC took the view that the inclusion of the preference also invalidated the conditions of rounds one and two.  All EIS relief was lost.

In fact, the position of the shareholders was not materially different before and after the introduction of the preference arrangements.  However the legislation does not allow for such pragmatism.

Great care is required at any stage of amending the constitution of a company.  Full and timely consideration of the growth strategy of a company is required so as to reduce the likelihood of changes.  Where changes are required, a review of the constitution is recommended at every stage to as to preserve the valuable benefits given by Enterprise Investment Schemes relief.

Gavin Poole is a partner in the corporate team at Stephens Scown. If you have any queries then please do contact Gavin on 01872 265100, or by email solicitors@stephens-scown.co.uk.