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


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


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


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 '