IR15 29 November 1994 ENTERPRISE INVESTMENT SCHEME The Chancellor proposes in his Budget to extend the tax reliefs available under the Enterprise Investment Scheme (EIS), and to simplify the scheme. The Chancellor's intention is to make the scheme more attractive, and easier for companies and investors to use. The tax reliefs will be extended by allowing the tax on a chargeable gain arising from the disposal of any assets on or after today, to be deferred where the gain is re invested in a subscription for shares under the EIS. The subscription will continue to qualify, in addition, for the existing 20 per cent income tax relief and capital gains tax exemption. The scheme will be simplified by - abolishing the interests in land rule which, broadly, denies relief when more than half of a company's assets are in the form of land and buildings; - abolishing the parallel trades rule which denies relief in some circumstances when similar trades are carried on by different companies under common control; - abolishing a rule which denies relief in some circumstances when a company makes a rights issue; - enabling shareholders to retain their capital gains tax exemption when companies which have used the scheme merge. All the above changes apply with effect from today. There are also a number of minor proposals to ensure the scheme provisions work as intended. Some of the changes also apply to Business Expansion Scheme (BES) companies. DETAILS Capital gains tax relief on re-investment in EIS shares 1. A new relief will allow an investor to defer a chargeable gain arising on any disposal when the investor subscribes for shares under the EIS. The deferred gain will be brought back into charge in certain circumstances, for example if the company ceases to be a qualifying company under the EIS rules. The relief will apply to disposals made on or after today. It will be available when the subscription for shares under the EIS is made in a period beginning one year before and ending three years after the disposal. 2. Income tax relief at 20 per cent will continue to apply. Where both reliefs apply to a subscription an investor may qualify for total initial tax relief of up to 60 per cent (20 per cent income tax relief and 40 per cent capital gains tax postponement in the case of a higher rate tax payer). Interests in land rule 3. The existing rule broadly prevents relief from being given if more than half of the value of the company's assets is represented by land and buildings. The rule must be observed throughout a relevant period of, generally, three years from the day the shares are issued. If the rule is broken, relief is withdrawn from the investor. This rule will be abolished with effect from today. Abolition will apply not only in the case of companies which have yet to issue shares under the EIS, but also to companies which have already issued shares under either the EIS or the BES in respect of that part of their relevant periods which has not yet elapsed. Abolition will also apply for the purpose of capital gains tax re-investment relief (see Press Release IR16). Parallel trades rule 4. The existing rule denies relief, for investment in a company, to an individual who is part of a group of persons who control that company and another company or business carrying on a similar trade. The rule will be abolished for shares issued on or after today. Rights issues 5. The existing rule may withdraw part of the relief given to an individual if the company makes a rights issue at a discount during the five years after the issue of the shares on which the relief is given. Relief may also be withdrawn if an individual disposes of the rights. The rule will be abolished for rights issues on or after today. Abolition will also apply for the purpose of the BES. Mergers 6. Under existing rules, some shareholders who have invested under the EIS can lose entitlement to capital gains tax exemption for future periods when companies merge. The rules will be changed for mergers (and other transactions to which sections 135 and 136 of the Taxation of Chargeable Gains Act 1992 apply) on or after today so that all shareholders will continue to enjoy the capital gains tax exemption on shares which they have held for at least five years when one company which has raised money through the EIS merges with another company which has also done so. The changes will also apply to the BES, and to mergers between EIS and BES companies. Other points 7. The Finance Bill will contain other measures to ensure the scheme works as intended. In particular: - the capital gains tax exemption will not be restricted where an investor has insufficient income tax liability to make full use of the 20 per cent relief; - a loss made on the disposal of shares to which some income tax relief is attributable will be an allowable loss for capital gains tax purposes. These changes will be backdated to the start of the scheme on 1 January 1994. 8. As another measure to ensure the scheme works as intended, the capital gains tax exemption will be restricted if the investor or another shareholder receives value from the company in certain forms. The types of value involved are set out in detail in sections 300 and 303 of the Income and Corporation Taxes Act 1988. They include the repurchase of share capital, the repayment of a debt, the making of a loan, the provision of a benefit and the transfer of an asset at less than its market value. This change will apply when such value is received on or after today. NOTES FOR EDITORS 1. The Enterprise Investment Scheme (EIS) was introduced in the last Budget to provide a targeted incentive, for new equity investment in unquoted trading companies by outside individuals, to help overcome the problems faced by such companies in raising small amounts of equity finance. It is available for shares issued on or after 1 January 1994. It replaced the Business Expansion Scheme (BES), except that it is not open to companies providing private rented housing under assured tenancies. 2. The existing reliefs for investors who subscribe for shares under the EIS are: - relief at the lower rate of income tax (20 per cent) on investments of up to pounds 100,000 a year; - capital gains tax exemption on shares held for at least five years; - relief against either income tax or capital gains tax if the shares are disposed of at a loss. 3. The main features of the EIS are: - unquoted trading companies must issue new ordinary shares and carry on a qualifying activity for a minimum of three years; - qualifying investors are individuals who are not connected with the company (broadly, employees, and shareholders with over 30 per cent of the capital, are connected with a company); - an investor can become a paid director (a "business angel") and still qualify for relief if he or she was not connected with the company, or with its trade, at any time before the eligible shares were issued; - the amount a company can raise in a year on which relief will be given is limited to pounds 1 million (pounds 5 million for a company engaged in certain shipping activities). 4. The estimated Exchequer cost of the changes proposed is pounds 5 million in 1995-96 and pounds 10 million for each of the tax years 1996-97 and 1997-98. 5. The changes will reduce the administrative cost to companies of using the scheme. For details of other Inland Revenue Budget measures of a deregulatory nature, see Press Release IR26. 6. The Inland Revenue have recently published a booklet (IR 137) which gives a full explanation of how the EIS works for companies and investors, including business angels. It is available free from any Tax Enquiry Centre or Tax Office and, if anyone has difficulty getting a copy locally, from the Public Enquiry Room, West Wing, Somerset House, London WC2R 1LB. They have also published a booklet containing internal guidance on the EIS, available from the Public Enquiry Room for pounds 4.