The idea of the Enterprise Investment Scheme is simple – you get income tax relief on your investment and avoid capital gains tax on the sale. But the rules are not just a minefield, they are a labyrinth of traps and disasters waiting to happen – and so discovered the shareholders of ProtonStar in the recent case of Averil Finn [2014] UKFTT 436(TC).
The company conducted a trade in relation to LED lighting and its shareholders, having followed all the proper procedures to the letter when making their EIS share subscriptions, obtained full income tax relief. Indeed, the company was successful and its directors sought to secure an AIM listing but rather than incurring the substantial fees of an AIM application they decided to achieve this by the reverse take-over of an AIM listed company, Enfis which itself was controlled by shareholders who had acquired their shares under the EIS start-up provisions. This is where the ProtonStar shareholders’ nightmare began…
The EIS rules provide that the income tax relief will be forfeited if in the three years following the EIS share subscription the EIS company falls under the control of another company, except in very limited and closely-defined circumstances. Specifically, the EIS legislation permits a takeover without a loss of EIS relief only where, immediately prior to the ‘share for share’ transaction employed to acquire the shares of the EIS target company the shares of the acquiring company are solely ‘subscriber shares’ – a term which is not defined anywhere presumably because everyone is expected to know that it means shares issued to the subscribers to the Memorandum of Association. Unfortunately, the reverse take-over of ProtonStar by Enfis did not satisfy these conditions. Take-over by a company which has issued shares other than to the first subscribers (which in practice is likely to mean virtually any active company) inevitably causes relief to be lost. Despite evidently having great sympathy with the taxpayer, the Tribunal therefore reluctantly found for HMRC.
This case serves to highlight what some may call the complexity of the EIS Rules but which others may regard as being quirky and counter-intuitive. Thus, if A Limited and B Limited are both EIS companies which want to merge and A Limited takes over B Limited, the B Limited shareholders lose their EIS relief even though A Limited shareholders do not – indeed later share issues by A Limited could qualify for EIS income tax relief. But using a brand-new holding company to acquire both A Limited and B Limited would permit both sets of shareholders to retain their EIS relief. On what planet does that make sense?
Perhaps the lesson to be learned is that ‘after care’ during the three years following the EIS subscriptions is as vitally important in preserving the tax relief as the attention to detail taken at the time of the share subscription – if that had been the case it is possible that the ProtonStar investors would have kept the relief in their pockets and saved it for a rainy day.
For more guidance on the byzantine complexity that is EIS, please get in touch with your usual BKL contact or use our enquiry form.
