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Author: Sacha Bright and Oliver Murphy
The Enterprise Investment Scheme Association (EISA) with the support of Nextfin is lobbying H.M Treasury for significant short term changes to the EIS and SEIS scheme to mitigate the threat to investors and investee companies from coronavirus.
While the government has introduced a number of measures to support businesses as they struggle as a result of Covid-19, businesses risk failing due to the current economic climate. As such, the EISA has written to the Government to request that the legislative restrictions on EIS and SEIS investments be lifted and additional income tax relief be made available for a limited period of time to encourage private investments to essential SME’s.
According to the Director General of the EISA, Mark Brownridge: “The objective for the industry is to continue to facilitate and deliver equity funding from private investors to start-up and scale-up businesses who have been identified as: most in need in the short term and have potential to be long term, high growth businesses”
He added: “Helping these businesses survive the short term crisis should enable them to achieve their long term ambitions. Once in that position, they will start to pay back that short term trust and investment through significant tax revenue and employment for the benefit of the UK economy.”
According to Sacha Bright CEO of Nextfin: “It's a no brainer. If you look at the jobs that EIS/SEIS creates, the businesses that grow and the resulting tax revenues the companies generate, it can often make a profit as shown in my case-study below.
“The government should relax the rules, increase the allowances and thousands of jobs and companies will prosper even with the coronavirus epidemic”.
The SEIS and EIS use tax reliefs as a means to incentivise private investors who are willing to recognise that significant returns could be achievable if they are willing to risk their funds by investing in early-stage businesses.
SEIS is a maximum investment of £150,000 targeted at helping start-up businesses to attract seed-funding, whereas EIS follows-on and allows a company to take up to £5 million in investment per year. Both of these schemes are capital equity investments in return for shares in a company.
The schemes play an important role in securing a smooth flow of risk equity capital from private individuals to early-stage businesses. Below are the four current SEIS/EIS tax reliefs available to investors:
Listed below are the available funding routes - time established - for a start-up and early-stage business up to three years. This may vary depending on the business owner and companies assets including the success of the business. However, for the majority of businesses, this is the type of funding that is most suitable and available to you at different stages in the life of your company.
But ultimately, equity crowdfunding is the best source of funding for early-stage businesses, as is highlighted below, and an increase in the allowances for EIS and SEIS would stimulate equity crowdfunding investment.
With the coronavirus outbreak turning small business upside down, the government needs to stimulate the economy in the most effective way possible. One such way is to ensure that those investing in growing businesses are encouraged to continue to do so, thus stabilising this vital part of the economy.
Since its inception 25 years ago, the SEIS and EIS have been responsible for almost £20 billion of private investors’ capital to create and drive the growth of over 27,000 businesses. But in these challenging times, the schemes must go much further to attract even more private investors to help keep businesses liquid.
Indeed, in the last year HMRC approved only 62% of the total of 3,270 requests from SMEs to raise money through the EIS submitted in 2018/19, down from 75% in 2017/18, according to Growthdeck, the private investor network. So far, investors have acted cautiously as a result of Covid-19 with many having ceased investments all-together which has had an impact on companies struggling to raise finance.
But increasing the threshold for EIS and SEIS investment and increasing the allowance will encourage new and follow-on investments, by mitigating a larger proportion of the risk for investors. At present, businesses can only receive a maximum of £150,000 through SEIS investments, and up to £5 million per year in EIS investments. Depending on the type of business, investors can only invest up to £100,000 on SEIS, and on EIS up to £2 million per year.
As SMEs struggle with shortages in cash flow, a way to stimulate investments would be for the government to temporarily raise the income tax relief credit to 50% for EIS and 70% for SEIS, and also increase SEIS investment threshold to £250,000 and £5 million on the EIS. Doing so would potentially unlock millions of pounds of extra funding which start-ups can use to fund their survival and allow for potentially hundreds of businesses to crowdfund and further increase revenue.
In 2018, equity crowdfunding provided £500 million in funding for early-stage businesses. But a result of the Coronavirus epidemic, there was a 75% drop in activity across the whole market. This demonstrates that if the government increased the SEIS and EIS allowances, we would see a dramatic rise in early-stage investments, protecting the future of our rising stars in business.
According to the EISA, while it realised that raising the income tax rate would incur extra costs to the Treasury, it believed the costs were far below those of the loss of revenue that small businesses provided the economy, as well as the human cost from potential lay-offs.
EIS and SEIS can actually return a profit for the government, as demonstrated below:
Let’s say that a private investor, as a result of the government lifting the SEIS threshold, is able to invest £250,000 in an early-stage business. Once that funding is received, 100% (£250,000) of that money goes to employing 10 staff all earning the living wage.
Those 10 employees earn £25,000 and pay income tax and national insurance which amounts to £4,432.36. The business collects this, which totals £44,432.36.
Over three years, this would equate to: £132,979.80 in tax revenues.
The employer pays £34,500 in National Insurance contributions and collects £26,592 in Income Tax.
Over three years, the two figures combined equates to: £266,276.08.
The cost to the taxpayer, with the proposed increase to 70%, is a £175,000 which could generate £61,479.80 in taxation revenues
This is a basic assessment of employing 10 people. Of course, some businesses will employ more, some will employ less. Some will fail within two years, others will thrive.
But in general, as is shown below, the tax revenues generated from just employing people, could repay the investment within three years.
Example: Possible tax revenue generation under present and proposed SEIS and EIS scheme
Current Allowance SEIS Investor Allowance= £100,000 SEIS Tax Relief: 50% Company Allowance= £150,000 |
Proposed Allowance SEIS Investor Allowance: £250,000 SEIS Tax relief: 70% Company Allowance: £250,000 |
£150,000 invested via SEIS |
£250,000 invested via SEIS |
£150,000 used to employ 6 staff |
£250,000 used to employ 10 staff |
6 employees= £25,000 per annum |
10 employees = £25,000 per annum |
Total tax per employee= £4432.36 |
Total tax per employee= £4432.36 |
Employer’s NI= £20,700 Over 3 years= £62,100 |
Employer’s NI= £44,432.36 Over 3 years= £133,297.08 |
Employer’s Income Tax= £26,592 Over 3 years= £79,776 |
Employer’s Income Tax= £26,592 Over 3 years= £132,979 |
Total NI+Income Tax over 3 years = £141,876 |
Total NI+Income Tax over 3 years= £266,276.08 |
Cost to the government= £150,000 - 50% (tax relief) = £75,000 |
Cost to the government= £250,000 - 70%= £175,000 |
Government Profit= £66,876 |
Government Profit= £91,276.08 |
The above flowchart is merely an estimation of how raising the SEIS, EIS allowance and tax credit threshold will result in increased taxation revenue for the government. This should not be taken as an exact figure, but rather an example of how private equity investments using this scheme can result in greater tax yields.
Because the threshold is much higher, it means that more money is available for the business. This means instead of having to lay off staff businesses can hire more employees, thus creating jobs while the government gets its money back. This, combined with a higher level of tax relief means that more follow-up investments are likely, benefitting even more companies.
Author: Sacha Bright & Oliver Murphy
Disclaimer
To the best of our knowledge, the information we have provided is correct at the time of publishing. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed. Nextfin is not liable for any damages arising from the use of or inability to use this site or any material contained in it, or from any action taken as a result of using the site.
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