Tax Efficient Company Financing

Tax Efficient Company Financing

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If you want to raise cash for your company, the Enterprise Investment Scheme offers tax incentives to draw in outside investors. But these tax breaks can be lost if you don’t use the money within a certain time. What do you need to know?

 

We’ve written about the pros and cons of the Enterprise Investment Scheme (EIS) on several occasions, but always from the investor’s point of view. However, if you’re a company in need of extra finance that your bank isn’t willing to provide, the EIS can be an alternative. The incentives on offer could have investors banging at your door to get in. But unless you use the scheme properly HMRC can withdraw the tax breaks and the investors might be banging on your door for another reason.

Basic conditions

HMRC’s website includes a useful summary of the conditions companies must meet before they can offer EIS shares to investors. Broadly, your company must be trading, i.e. not one that mainly manages investments, and must not be on HMRC’s list of trades specifically excluded. More conditions apply once you’ve banked the investors’ money and if these aren’t met the investor will lose their tax breaks.

Have you employed the money?

Nice though the idea is, you can’t just use the money to fund a fabulous lifestyle for you and your fellow directors. It must be “employed” for a qualifying purpose. Exactly what this means isn’t defined in the rules, but recently the tribunal has considered this point and decided that employed means that the money has been:

  • spent on increasing net trading assets of the business. For example, buying new machinery or employing more staff to increase or improve profits; or
  • added to existing funds to meet trading losses or current trading costs. In other words, it can be used to keep your company afloat; or
  • earmarked for a particular purpose, the expenditure for which may not arise until a later accounting period. For example, to fund the building of larger business premises.

Tip. EIS status won’t be affected where only 5% or less of the money hasn’t been employed.

Effective earmarking

Major projects can easily take over two years from inception to completion so you’ll need to convince HMRC that the money raised has been properly earmarked, even if it hasn’t been spent, But be warned HMRC will want evidence of a specific purpose for earmarking not just a vague idea that it will be used for something definite.

Tip 1. Keep records to back up the reason for earmarking funds. For example, ask your bookkeeper to set up a separate heading in the company accounts through which the ins and out of the EIS funds are recorded. A separate bank account isn’t necessary, though it wouldn’t hurt. Also record progress by having updates about the EIS project in board meetings which are minuted.

Tip 2. For projects that require funding over a long period, consider a series of EIS share issues spread over time so the money is raised only when you need it. This will reduce the risk of HMRC challenging whether the funds are earmarked.

 

If you would like more tips about tax and finance, contact DLR Accountants today to find out more.

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