Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) tax relief

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What are SEIS and EIS?

The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are government approved schemes which provide significant tax reliefs to UK tax paying individuals who invest in early stage UK companies by subscribing for shares in such companies. This means that these investors are able to make investments with a lot less risk involved.
 

How can SEIS and EIS help your studio?

For any young business in the games sector, SEIS and EIS are important to understand as the reliefs they offer will often be a key incentive for a potential investor to provide early stage equity investment in your studio.
 

Is the SEIS or EIS investor investing in a special purpose company?

It is becoming increasingly common for studios to set up a special purpose company for each new game project, for reasons relating to the video games tax relief and other commercial reasons. As a practical point, it is important to consider whether the SEIS/EIS investor is investing in a special purpose company that you have established solely to develop and exploit one game, or a company that intends to develop numerous games. This is likely to have a material impact on the deal that you reach with the investor.

If you are seeking SEIS or EIS finance for a special purpose company established to develop and exploit a single game then you should take specialist tax advice because there are some restrictions on the use of SEIS and EIS finance in this context.
 

What are the key points to know about SEIS and EIS?

A summary of the key points is as follows:

Main rules that apply to both SEIS and EIS

  • SEIS and EIS are tax reliefs that benefit the individual investor – not the company receiving finance.
  • Only eligible UK tax paying individuals can benefit from the relief. If you are seeking to raise finance from an individual investor that does not pay tax in the UK or a company or other legal entity, SEIS and EIS relief will not apply.
  • SEIS and EIS reliefs will generally not be available to founders or management of the fundraising company.
  • The investors’ investment must take the form of full-risk ordinary shares (and not the form of debt, convertible debt or other structure).
  • The business that is carried on by the fundraising company must “qualify” under the specific rules (e.g. a video game development company will generally qualify). This is the area that most often requires specialist advice.
  • The shares in the fundraising company that are subscribed for by the investor must be:
    • full risk ordinary shares; and
    • held for 3 years,

or the reliefs will be invalidated.

Main rules that apply specifically to SEIS

  • The fundraising company must have 25 or fewer employees, gross assets of no more than £200,000 and must be no more than 2 years old.
  • The maximum amount a company can raise under SEIS is £150,000 capped at £100,000 per individual investor per tax year.
  • The investor can offset up to 50% of the investment against his/her income tax liability (e.g. for an investment of £100k the investor could offset £50k against its income tax liability, which means only £50k of the investment is at risk, assuming the investor has an income tax liability of at least £50k).
  • No capital gains tax will apply to the sale of the shares in the company.
  • The investor can set off any loss on its investment against its income tax liability.

Rules that apply specifically to EIS

  • The fundraising company must have 250 or fewer employees, gross assets of no more than £15 million and must be no more than 7 years old.
  • The maximum a company can raise under EIS is £5,000,000 capped at £1,000,000 per individual investor per tax year.
  • The investor can offset up to 30% of its investment cost against its income tax liability (e.g. for an investment of £100k it could offset £30k against its income tax liability, which means only £70k of the investment is at risk, assuming that the investor has an income tax liability of at least £30k).
  • No capital gains tax will apply to the sale of the shares in the company.
  • The investor can set off any loss on its investment against its income tax liability.

May 2018: Update

Changes to EIS/SEIS and new HMRC Guidance: Why there must be a 'risk to capital' for an investment to qualify

As from 15 March 2018, the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) are subject to a new ‘risk to capital’ condition.  Harbottle & Lewis LLP answers some of the key questions game studios seeking investment under SEIS and EIS may have regarding this new condition.

Why have these changes been introduced?

SEIS and EIS are schemes that were designed from the outset to encourage investment in, and to promote the long-term growth and development of, high-risk companies.  The changes we describe here result from HMRC’s perception that some SEIS/EIS financing was being structured in such a way that the risk to the investor was being substantially mitigated.  For example, a company may have raised finance under SEIS/EIS promising the investors a return from revenue streams that were guaranteed at the time of the investment.  HMRC’s guidance (referred to below) cites, by way of example, a film production company that has pre-sold a film at the time the SEIS/EIS investment is made, the proceeds of such pre-sales being used to secure the investors’ investment in the film. 

What is the ‘risk to capital’ condition’?

The ‘risk to capital’ condition has two limbs:

1.the company in which the investment is made must have the objective to grow and develop over the long term; and

2.the investment must carry a significant risk that the investor will lose more capital than they gain as a return (including any tax relief).

How do I know if a proposed investment satisfies the condition?

HMRC has published guidance (which includes various worked examples) to help companies and investors answer this question. The guidance is available here, and the answers to the questions below summarise the key elements of it.

The general theme from the guidance is that HMRC is seeking to ensure that SEIS and EIS are only used to raise capital that is truly at risk (and not protected or secured by the investee company in any way). HMRC has said that it will take an holistic and (according to the guidance) “reasonable” view (taking into account sector/industry standard practice) in assessing whether the condition has been met.

Can I ask HMRC if the condition is satisfied?

It is possible for a company to apply to HMRC for ‘advance assurance’ that its shares will qualify for the reliefs offered under SEIS and/or EIS.  This process, which can take several weeks, involves the company making a detailed submission to HMRC including its business plan, budget, articles of association and identifying potential investors.  HMRC examines the submission and applies the ‘risk to capital’ test and the other SEIS/EIS qualifying criteria to the facts submitted to it.  Following this, either it provides advance assurance to the company that its shares will qualify for SEIS/EIS (or it may request further information about the submission) or it may confirm that the company’s shares will not qualify.  It is important to note, however, that receipt of advance assurance that a company’s shares will qualify does not guarantee that the tax reliefs will be granted when they are applied for (for example if the company has not been operated in the way described in the advance assurance submission). 

If advance assurance was obtained prior to 15 March 2018, it is important to bear in mind that issues of shares on or after that date will be subject to the new ‘risk to capital’ rules (which may not have been applied by HMRC in granting advance assurance).  Companies faced with these circumstances should take professional advice prior to issuing new shares.

Does the company have ‘objects to grow and develop’?

According to the guidance, HMRC will take into account various factors to build up an overall picture of the relevant company. The guidance makes clear that companies established for the sole purpose of developing and producing one specific project which will be completed within a fixed timeframe are unlikely to qualify. Instead, it expects a qualifying company to re-invest capital with a view to expanding its business (such as by increasing revenues, expanding its employee or customer base or building a brand) over a period beyond the EIS and SEIS minimum holding periods of 3 years.

For a games studio, this requirement is likely to translate into a development company that is raising money either for a slate of projects (and which does not intend to return funds to investors based on the performance of say a game in a single format but re-invests any profits from a successful game into the development of sequels or new formats or other new projects) or a ‘game as a service’ where the studio’s intention is to continually develop and evolve a single game over the long-term with a view to expanding its appeal and growing its revenue generation.  We are not aware that the ‘game as a service’ model has been tested with HMRC following the introduction of the risk to capital condition, but applying HMRC’s guidance provides sound arguments that such a model should not fall foul of the condition merely because it involves the development and exploitation of a single game, provided that profit from the game is re-invested in the continued development and improvement of the game.  It is likely, however, that any business plan submitted to HMRC (as part of a submission for advance assurance that the studio will qualify for SEIS and/or EIS relief) would need to provide a contingency plan for any ‘game as a service’ that was not commercially successful and which did not therefore merit further investment.  In such a case , the studio’s business plan would need to contemplate investment in new projects (rather than winding up the company).

How will I know if an investment will carry a sufficient ‘risk to capital’ to satisfy the condition?

As noted above, the ‘risk to capital’ condition is primarily targeted at making low risk tax motivated investments ineligible for the reliefs. To qualify, invested capital must be ‘at risk’. According to the guidance, the risk of loss of capital is determined by considering the risk of losing monies invested and the net investment return to the investor. Net investment returns would include dividends, interest payments, fees, and up-front tax relief. So, for example, an investor’s investment would not be considered to be ‘at risk’ if its return to the investor were to be secured by the UK’s video games tax relief.

HMRC will also pay close attention to any existing or proposed contracts which guarantee the relevant company a secure revenue steam (in particular where that revenue stream would cover the proposed investment amount). This could, for example, take the form of a publishing agreement which is in place at the time a games studio is seeking to raise funds under either EIS or SEIS. Whilst the existence of such an agreement will not necessarily result in automatic disqualification, the nature and terms of that agreement will be relevant considerations (and it may be that only the amount of the investment not covered by the revenue stream qualifies for SEIS or EIS relief).

How do I demonstrate to HMRC that my company and the proposed investment satisfy the condition?

The guidance states that a company will need to demonstrate its growth and development objectives in a business plan and we assume that any submission for advance assurance will need to explain how an investor’s capital is significantly at risk.  It is also worth noting that HMRC now require that any advance assurance submission identifies the investors who are likely to invest; their stated objective being to eliminate speculative advance assurance applications from companies that do not know where their investment is coming from.

Separately, care should be taken in the production and distribution of any marketing materials produced for investors – reference in those documents to low risk or guaranteed minimum returns will point towards an investment falling foul of the condition.

Will this make raising SEIS and EIS investment for games studios tougher?

In our view, not necessarily. It is uncommon for early-stage games studios to have (for example) significant existing secured revenue streams in place prior to a proposed SEIS or EIS investment. Provided that the studio has been established by its founder for the long term and plans to invest funds raised under EIS and SEIS in the development of a number of video games (or, subject to the comments made above, possibly a single ‘game as a service’) satisfying the condition should (speaking broadly) not pose significant difficulty.  That said, owing to the uncertainties that the new rules create for certain investment funds (see the paragraph below) games studios may find that there are fewer opportunities to raise finance from these sources.

How will the new condition impact investment funds?

The guidance makes it clear that qualifying investors must be third parties who have no intention of running the company (although a board representative may be permitted). Some investment funds will be affected if they have historically played a central role in setting up and operating the special purpose vehicle into which they will then invest their investors’ funds. The guidance suggests that this practice will not satisfy the ‘risk to capital’ condition.

Will HMRC monitor whether the conditions are actually fulfilled post investment?

According to the guidance, HMRC will carry out post-investment checks to assess whether the SEIS/EIS criteria were properly satisfied and whether the investment is being used for the stated purpose. HMRC has the power to withdraw the relevant tax reliefs if they consider that a company no longer qualifies under SEIS and/or EIS, notwithstanding that advance assurance may previously have been given.

Where can I find out more?

There is a plethora of online guides and resources relating to SEIS and EIS. We suggest looking at the HMRC advice as a starting point, which is available here and here.

The rules are complex so we suggest that you seek specialist advice if you wish to establish an EIS or SEIS. If you would like to discuss the ‘risk to capital’ condition in further detail, or seek advice as to whether your company or a proposed investment is likely to satisfy the EIS and SEIS criteria please contact Charles LevequeMark Phillips or Mark Knight for further information about EIS or SEIS.

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