Tax Law Matters

Many small companies rely on EIS tax relief to bring in equity investors. Just bear in mind that your obligations to your shareholders start, not end, with the cheque arriving.

A very smart lawyer friend once gave me some excellent advice: “never try to make case law”. It would be another 10 years before I realised why that was such excellent advice. Surely, one of the great joys of English law is the way in which anyone can challenge it and refine it?

What was the problem?

I inherited the chair of the board of a company that found itself challenging HMRC on the interpretation of tax law in respect of EIS that had been granted to shareholders but was then threatened with being withdrawn.

The problem as that some shares had been paid before others. This is called “a preference” and you are not allowed to do that under EIS regulations. So I inherited that issue along with the company chair. Around £800,000 of EIS relief was at risk. Around £933 of preferences had been repaid. A thorny problem that resulted in strong representations from the shareholders and previous executives.

So we went to our lawyers and asked them to “fix this”.

Here is the wording in the HMRC Manual

Shares issued on or after 6 April 2012
The shares must be ordinary shares which, throughout the three year period (VCM10540) carry:
- no present or future preferential right to dividends where either:
 - The rights attaching to the share include scope for the amount of the dividend to be varied based on a decision taken by the company, the shareholder or any other person. Note: this exclusion covers only those shares which carry preferential rights and does not therefore prevent the voting of dividends in respect of non-preferential shares, nor does it prevent shareholders from choosing to waive a dividend payment should they wish to do so; or
 - The right to receive dividends is ‘cumulative’ - that is, where a dividend which has become payable is not in fact paid, the company is obliged to pay it a later time, normally once funds become available.
- no present or future preferential rights to the company’s assets on its winding up, and
- no present or future right to be redeemed.

Many Tribunals, Appeals, and long sessions with our excellent Counsel, Joseph Howard, ensued.

What was the outcome?

The final point revolved on “is this too small (‘de minimis’) to worry about”

Here is the very well worded judgment from the Upper Tribunal.

We lost. The shareholders were demoralised. The company failed to raise further funds.

What can you learn from this?

Stick to the exact wording of the rules for EIS. Take advice from people who know not just the law (always useful), but who can explain the real world consequences to you and your company. The consequences can be very severe indeed, and EIS compliance needs to have a monthly check point from the CFO to the Board for the whole period of risk (from incorporation to 3 years and a day after the last investment, at least).

EIS is a fantastic tax break. It comes at a cost in terms of compliance.