IN his Budget speech in November 1993, the Chancellor, Kenneth Clarke,
announced a successor to the Business Expansion Scheme (BES). As,
latterly at least, BES funds were being channelled more into rented
housing schemes and less into fledgling businesses, its demise was
widely expected and the scheme ceased as from December 31.
The proposed replacement, the Enterprise Investment Scheme (EIS), was
designed primarily, in the Chancellor's words, ''to help those who are
looking to invest their expertise as well as their money''.
While this may be the stated aim of the EIS, it is worthwhile
considering the extent to which the new legislation helps to achieve
this in a practical sense. The proposed legislation, as included in the
1994 Finance Bill, is, in fact, broadly similar to the scheme which it
replaces.
However, the EIS, which is effective in relation to issues of shares
on or after January 1 this year, differs from the BES in a number of
important respects.
The maximum investment eligible for relief in a single year is
#100,000 per individual, or #200,000 for husband and wife.
Tax relief on the investment is given at the 20% rate of tax, making
the maximum relief per person #20,000.
The maximum amount which may be raised by a qualifying company
(essentially an unquoted trading company) in any one tax year is
restricted to #1m, after which the company must wait at least six months
before another issue of shares may be made.
If shares have been issued before October 6 in a tax year, shares to
the value of #15,000 (or 50% of the amount subscribed prior to October
6, if smaller) may be treated as issued in the previous tax year.
However, so far as 1993/94 is concerned, as the BES was in operation
during that year, the maximum relief under both the BES and EIS is
limited to #40,000.
A clawback of the relief will be made if the shares are sold within
five years of their date of issue. Any capital gain arising will be
taxable and any loss suffered will be allowable. A capital loss may be
offset either against capital gains of the current or future tax years
or, on making a claim, against general income in the year of the loss
(and, in certain circumstances, the previous year) at the highest rate
of income tax.
If the shares are sold after the five year period any gain is tax free
although, unusually, a capital loss is allowable and may be relieved in
the same way as losses sustained when the shares are sold within five
years.
The investor may become a paid director of the company -- provided he
has not previously been connected with the company or was not previously
an employee of any person who previously carried on the trade of the
company.
As mentioned above, enabling the entrepreneur to both manage and take
a stake in the business was the primary aim of the EIS. However,
achieving this aim in practice may be fraught with difficulty. In many
situations, the potential investor will already have been connected with
the issuing company as director or employee, for example, in a
management buy-out.
On the other hand, in a management buy-in, provided that the potential
director is first an investor and then, after the shares have been
allotted, becomes a paid director, EIS relief would be available as long
as all other conditions are met.
However, having said this, it is likely that EIS investments will be
geared more towards business start-ups than to the acquisition of
existing businesses, as the combined effect of due diligence costs and
the #1m restriction on issued capital may well inhibit investment in the
latter in all but the smallest cases.
A further point which arises in relation to the stake the director may
take in the business is that his investment is restricted to 30% of the
issued Ordinary share capital or voting power of the company, whichever
is greater.
In arriving at the 30% limit, it is necessary to include not only the
director's own shareholding but also those of his ''associates'' (which
include, broadly, his spouse, children, parents, and companies connected
with him). The provision effectively means that the shareholdings in the
company will be widely dispersed and, potentially, the company could
suffer from a lack of commercial direction if the shareholders do not
see eye-to-eye on its running.
There is also the related question of the level of remuneration which
the director may take from the company. In this instance, the proposed
legislation merely states that the remuneration should be ''reasonable''
for the services rendered.
Remuneration in this sense includes not only the director's fees but
also any salary paid and benefits provided. Unfortunately, no clear
guidance has yet been given by the Revenue as to what constitutes
reasonable remuneration and, in these circumstances, it would be wise to
interpret conservatively this particular aspect of the EIS legislation
to minimise the possibility of the relief being jeopardised.
It is also worthwhile mentioning that a director may receive other
payments (for example, dividends, rents and interest) from the company
without affecting his entitlement to EIS relief, again provided that
such payments are ''reasonable''.
While the extension of the BES in the form of the EIS is to be
welcomed, there must be some doubt as to the attractiveness of the new
relief in many commercial circumstances. However, it remains to be seen
how much interest there will be in the new scheme. It may well be that a
relaxation of the current restrictions will be necessary to make it work
as the Chancellor intended.
' While the extension of the BES in the form of the EIS is to be
welcomed, there must be some doubt as to the attractiveness of the new
relief '
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