When a startup founder establishes their business they will likely have a strategy in mind for how they will fund it. This generally starts with savings, grants and bootstrapping tactics. In most cases this will be followed by an investment round from angels or other invsetors. What is often overlooked in Northern Ireland is the HMRC SEIS tax reliefs available to investors who invest in high growth, innovative startups.
This scheme was created by government to encourage investment and reward investors for supporting what is both the most high risk of all asset classes but also potentially the most rewarding. The rules change from budget to budget so it’s crucial to research thoroughly and to take advice when applying or investing.
Not all businesses are suitable so below are the SEIS Eligibility Criteria for startups as described by Seed legals.
The Gross Assets Test
A company looking to secure SEIS investment must have under £200,000 in gross assets pre-money, whilst those looking to secure EIS investment must have less than £15 million in gross assets pre-money.
The Number of Employees Test
A company looking to secure SEIS investment must have no more than 25 employees, whilst those looking to secure EIS investment must have no more than 250 employees.
The Trading Time Test
To be eligible for SEIS funding, a company must have been trading for less than 2 years. It should be noted that the date when a company starts trading is different to the date of incorporation detailed on Companies House. When establishing whether this test has been satisfied, HMRC will review the company’s profit and loss accounts rather than the date of incorporation.
UK Permanent Establishment Test
In order to raise funds under SEIS and EIS, a company does not necessarily need be a UK company in order to qualify. A foreign company ( including those in Republic of Ireland) can have a permanent establishment in the UK, through which a substantial part of the company’s business is conducted. In certain circumstances, having an employee based in the UK may satisfy the permanent establishment test although this should be assessed on a case by case basis.
The Partnership Test
The company looking to raise funds under SEIS or EIS must not be a member of a partnership with another company, as this will be flagged by HMRC.
From an investors perspective this tax incentive provides some reward for the risk profile of the investment. Please remember though: tax rules can change and benefits depend on circumstances but below is a summary from Wealth Club.
SEIS tax relief overview
Income tax relief of up to 50%
A £100,000 investment could provide a £50,000 saving on that year’s income tax bill. To claim this, the investor must have sufficient income tax liability in the first place and hold the shares for at least three years.
Generous contribution allowance
Invest up to £100,000 per tax year.
Carry back contributions to the previous year, assuming investor has the allowance. So if they use both years’ allowances they could potentially invest up to £200,000 in one go. Carry back also gives them the option to offset the tax relief against the previous year’s tax bill, so you could potentially get back tax they’ve already paid.
Investors normally pay no CGT when realising SEIS shares, if they have claimed income tax relief on them and the companies still qualify.
50% capital gains reinvestment relief
Investors could reduce the CGT on gains made elsewhere by up to 50%. To benefit, they must have had the income tax relief in the same year.
Inheritance tax relief
An investment in an SEIS-qualifying company should benefit from 100% relief from inheritance tax, provided the investment is held for two years and at the time of death.
If things don’t go to plan, investors can choose to offset any loss, less the income tax relief received, against your income tax bill. So, an additional-rate taxpayer can effectively reduce a total loss of £1 to 13.5p once all the tax reliefs available have been taken into account.
How SEIS tax relief helps reduce any losses and magnify any gains?
When an investor invests £100,000 in an SEIS, because of the income tax relief of up to 50%, the effective net cost could be as little as £50,000. 50% CGT reinvestment relief could provide an additional boost of £14,000 or £10,000 (depending on whether 28% or 20% CGT applies).
Loss relief allows investors to write off any losses against income tax. So, if the investment falls to zero, they could in effect deduct the £50,000 loss from their taxable income. This gives a potential tax saving of £22,500. Add to that up to £14,000 capital gains reinvestment relief and the maximum effective loss could be as little as £13,500. Meanwhile, if your investment grew by 50%, thanks to the tax relief, you could be looking at an effective gain of 114%.
How do investors claim SEIS income tax relief?
You can normally claim SEIS tax relief when you file your tax return. You’ll either reduce your tax bill for the year or receive a refund for tax you’ve already paid.
A startup founder should apply for this approval when they start planning an investor round. The application process involves the submission of relevant forms, a business plan including valuation/ financial projections and can take 6-8 weeks. Seedlegals and Sapphire Capital Partners are well placed to provide support and guidance in the application process. Like all investor rounds, founders should be cautious when entering into discussions with investors. This tax incentive is a valuable tool for the startup founder but they should be wary of investors only approaching a project for the tax relief. At this very early stage of any business needs investors with the businesses best interests at the forefront of their involvement.