Money for nothing – tax time trap for investors 

HMRC has recently provided guidance on the use of Advance Subscription Agreements and the interaction with investor tax reliefs.  

Technology, Innovation and Growth tax expert Stephen Martin explains more.  

The government-approved Enterprise Investment Scheme (EIS) and its junior version the Seed Enterprise Investment Scheme (SEIS) represent great opportunities for technology and high growth companies to attract investors.  

The income tax reliefs on offer can de-risk a potential investor by 30% (under EIS) and even up to 50% (under SEIS). And with no capital gains tax on an exit, this can be an extremely tempting proposition for companies to offer.   

Raising funds under EIS and SEIS – a common problem 

Provided the legislation is navigated carefully and the fundraise is implemented correctly, the majority of trading companies can qualify for these schemes, at the very least in the first few years after incorporation.  

One of the wrinkles in the rules is that shares must be subscribed for in cash – convertible loans for example do not qualify for EIS or SEIS – and this has led to some difficulty.  

It is sometimes not practical, or prohibitively expensive, to raise cash via a formal funding round, and the problem often having to be resolved is what companies can do where they need capital between funding rounds. 

A workaround? 

The answer is an Advance Subscription Agreement (ASA). An ASA enables investors to pay subscription funds to a company prior to shares being issued.  

Usually the shares are then issued at a later date – the next formal funding round – and HMRC is known to accept these arrangements as qualifying for EIS or SEIS, unlike convertible loans.  

Until recently, HMRC had not published its views on ASAs. It now has, and this has raised a number of interesting points for investors and companies.  

HMRC’s guidance 

Firstly, HMRC anticipate ASAs to be simple in nature. The more complex the ASA, it says, the higher the risk will be that the investor will not be able to claim EIS or SEIS tax relief.  

HMRC makes the point the ASA should not provide any benefits, such as investor protection, should not be refundable, variable, or bear interest, and the subscription payment must not be a loan simply described in another way (in which case this would be a convertible loan and not permitted as explained above).  

Secondly, HMRC says that the company will need to demonstrate how the ASA fits into the business plan and planned expenditure on growth and development.  

This should be addressed in any Advance Assurance sought from HMRC, and reinforces the key point about how all EIS or SEIS funds raised need to be used for the prescribed purposes set out in the legislation.   

The 6 month limit 

Finally, HMRC says there should be a longstop date, which it expects to be no more than 6 months from the date of the agreement.  

It is this final expectation which, in our view, represents the most significant announcement from HMRC, and is not in line with market practice.  

Given that the shares relating to the ASA tend not to be issued until a formal raise is being completed, it is not always possible to meet this 6-month deadline. This is particularly so in the current economic climate where investors might be more cautious, and companies not able to complete a funding round.  

It is an important point to note that HMRC guidance is not law. Nevertheless, the Government’s published views can be significant if any case were to be taken to Court by HMRC about the eligibility of an ASA for EIS or SEIS.   

If you have used or would like to use an ASA and are concerned about how HMRC’s guidance could have an impact, please contact Stephen Martin.