Tax Talk: Tax incentives for start-ups: find out more
Read time: 5 mins
Service: The early life of a start-up can be a nerve-wracking time. We explain a variety of schemes that can provide vital support to a fledgling company.
During the start-up phase of a company’s life cycle, there are a few hurdles it’s likely to face, especially if the company is considered high-risk. Two of the main challenges are raising finance and retention of skilled staff.
Fortunately, the UK offers a number of tax-efficient incentives that encourage growth and investment in start-ups and small companies. With proper structuring and planning, UK start-ups can make use of these regimes by sourcing important early-stage investment and by incentivising employees.
Raising finance
The traditional way for start-ups to access funding is through commercial loans from banks. This is often supplemented by third party investors where traditional sources are not enough.
But attracting investors can often be a challenge, because of the high risk associated with start-ups. The UK’s Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) help to encourage third-party individuals to invest in a new company.
What are the EIS and SEIS?
These regimes are designed to help smaller, riskier trading companies to find investors. The EIS allows a UK individual investor to obtain Income Tax relief on newly subscribed shares in a qualifying company. This is for up to 30% of their investment. Once eligible, the qualifying investments can also be sold by the investors without incurring Capital Gains Tax (CGT).
The SEIS is similar to the EIS but is aimed at even smaller companies (those in the very early stages of their start-up). The SEIS offers higher tax relief to investors (up to 50% Income Tax relief) to reflect the higher risks of investing.
Does your company qualify for EIS and SEIS?
There are a number of requirements that need to be met by start-ups to qualify for EIS or SEIS. These include:
- It must be a trading company or holding company of a trading group, which isn’t controlled by another company.
- Trading activities carried on by the company/group must not substantively include ‘excluded activities’. Excluded activities include banking, certain financial activities, property development and farming, among others.
- Companies must be within the first seven years of trading to qualify for EIS relief, and within two years of trading to qualify for SEIS relief. HMRC restricts the use of SEIS if EIS has already been used to receive investment.
- The company or group must not have gross assets of more than £15m or more than 250 employees before issuing shares and must not have £16m of gross assets after the issue of shares, for the shares to qualify for EIS relief.
- For SEIS, the company’s gross assets limit is £200,000 and the company must have no more than 25 employees for the shares to qualify for SEIS relief.
What about the investor?
For EIS and SEIS, investors have to be individuals:
- who are not employees of the company.
- for EIS, who are not directors of the company – subject to certain exceptions.
- who do not have more than a 30% stake in the company, in terms of shareholding, voting rights, and certain other economic tests.
What tax relief is available?
Individual investors can claim Income Tax relief of up to £300,000 per tax year on newly subscribed EIS shares (30% of investment) and £50,000 per tax year on newly subscribed SEIS shares (50% of investment). Investors may get more generous relief, subject to meeting specific criteria, for ‘knowledge intensive companies’.
There are also generous exemptions on the ultimate disposal of the EIS and SEIS shares.
What are the rules on the raised investment?
Funds received via EIS subscribed shares must be used in the company’s trade within two years of being issued. For SEIS funds, this is within three years or two years if there is an existing qualifying trade.
Companies must ask for prior approval from HMRC to implement the schemes. They can apply for advance assurance, before the investment, to reassure potential investors that the company meets the qualifying conditions for EIS/SEIS relief.
Retention of skilled staff
For start-ups, especially in the current workforce climate where recruiting and retaining key staff is difficult, there is much thinking around ays to encourage staff retention besides increasing salaries and bonuses (especially for cash-strapped companies).
The UK’s Enterprise Management Incentive (EMI) scheme has been a popular choice for start-ups and SMEs that want to reward and incentivise their employees in an alternative way to cash. This may also act as a form of cash injection into the start-ups.
What is the EMI scheme and what are the advantages?
The scheme works by granting EMI options to employees. This means they can acquire shares at a fixed price at some pre-arranged point in the future, rather than giving away equity now. Over a three-year period, the company can grant options with a value up to £3m, with individual employees being granted options of up to £250,000.
The main benefits to eligible employees include:
- No Income Tax or Class 1 National Insurance contributions (NICs) on grant of the EMI options.
- On exercise of the employee’s options to shares, there will be no Income Tax or Class 1 NICs to pay, provided that the exercise price paid to acquire the shares was not less than their market value at the date of grant of the options, and no ‘disqualifying events’ occurred.
- On sale of the EMI shares, the employee will be subject to CGT on any chargeable gains. Employees may however be eligible for business asset disposal relief (BADR) on qualifying shareholdings, which would mean gains are taxed at lower rates of CGT.
Does your company qualify?
The EMI scheme is aimed at start-ups and SMEs, so various qualifying conditions and limits have been imposed to restrict the companies that can use the scheme. These include, but are not limited to:
- Gross assets of less than £30m and fewer than 250 employees at the date of grant of options.
- As with the EIS scheme, the company must be a trading company or holding company of a trading sub-group, which isn’t controlled by another company. The company’s trade must also not consist of substantively ‘excluded activities’.
There are also certain conditions for employees to be considered eligible for the scheme. We would therefore encourage discussing these further to ensure viability.
There is further information about the EMI scheme and other share schemes in our previous Tax Talk article.
What next?
If you are a start-up or SME, the EIS, SEIS and EMI regimes we describe above all play important roles in helping to secure a company in its early stages. They can provide support with both capital and staff incentivisation. Other initiatives may be appropriate for your company such as R&D relief and government grants.
If you’d like to discuss any of this further, please contact Ivy Ojediran, Tafara Golding or your usual PKF Littlejohn contact.