Ongoing risks for venture capital reliefs such as EIS

For high growth businesses that have benefitted from investment under venture capital schemes such as SEIS and EIS many companies focus on complying with the rules at the time of receiving an investment and overlook the ongoing compliance requirements. The regulations can be very complex and our article SEIS and EIS Pitfalls focusses on considerations at the time of investment and below we have set out some key principles and red flags for companies who have or are considering benefiting from investment under venture capital schemes. 

Within two years, an EIS company must spend all EIS money on a qualifying purpose (excluding ‘insignificant’ amounts, although ‘insignificant’ is not defined). The time restriction is for two years from the share issue, or if the company is preparing to trade at the time of the issue, within two years of the trade commencing. For this reason, many companies will keep EIS money in a separate account to make it easier to demonstrate how this requirement has been met.

Companies accessing the benefits of venture capital schemes need to comply with rules up to the termination date, which will be the later of the the anniversary of the share issue date or, if a company was not trading or carrying on research and development at the date of the share issue, three years after the trade commenced. The termination date is normally shown on forms EIS2 and EIS3.

Red flags for conditions that need to be met until the termination date include the following:

• Appointment of directors: Shareholders or their associates (e.g. relatives) should not be directors or non-executive directors.
• Receipts of value: The rules affecting receipts of value are complicated but the receipt of benefits or making any payment to an EIS investor should be carefully considered. This includes share buybacks made by the company from any, including non-EIS investors.
• Change in trade: Careful consideration needs to be given to changes in trade, in case this gives rise to the cessation of a qualifying trade (there is scope for changing one for another trade) or diversification (inadvertent or intentional) beyond the 20% rule into a non-qualifying trade. 
• Continued investment in knowledge: For EIS investments relying on the knowledge-intensive company conditions, the skilled-employee or R&D expenditure cost conditions need to continue for three years following the investment. Failure to do so will lead to the company being disqualified.
• Acquisition: Acquisitions by an EIS company of an older company can disqualify an EIS investment and also lead to the ‘first commercial sale’ date being moved forward preventing subsequent EIS investment.  
• Changes to shareholder rights: Changes to shareholder rights can lead to disqualification of EIS investment. While reorganisations are common for scaling businesses, care should be taken to ensure changes in rights or consolidations are not treated as deemed disposals for EIS purposes, that rights are mirrored in share for share exchanges clearance is received from HMRC. Secondly, care should be taken with the issue of new classes of shares in case they inadvertently convey preferential terms for the EIS shares, as can  happen with growth share schemes or sweet equity arrangements. 
• Change of control of the EIS company: An EIS company should not come under the control of another company and nor must there be arrangements that would allow for that to happen. This rule can be waived where in share for share exchanges that comply with S247, ITA, 2007. However, note that instruments (such as convertible loan notes or options) that create a situation where a change in control could arise in the future would lead to disqualification. 
• EIS company control of another business: An EIS company must not control another company that is not a qualifying subsidiary.
• Changes in UK permanent establishment: UK branches or agents of overseas companies must maintain their UK presence.

While there is no need for an annual EIS audit, companies are required to notify HMRC (and investors) within 60 days of a breach of a condition and investors are also required to notify HMRC within 60 days of being notified of the breach.

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