The Enterprise Investment Scheme (EIS) and a lack of ‘Flix-ibility: Flix Innovations Ltd (2015)
This case is an illustration of how complex the Enterprise Investment Scheme (“EIS”) and Seed EIS can be and also the unforgiving approach often adopted by HMRC and the Courts in relation to ‘getting it wrong’.
The First-tier Tribunal (FTT) held that a right to repayment of the nominal value of shares in priority to other shareholders on a winding up was a preferential right. This meant that one of the statutory conditions for EIS was breached and, as such, those shares were not eligible for the attractive tax reliefs.
Like many Companies, Flix required further finance in order to develop the business.
To make such an investment more attractive for investors, the company’s share capital was reorganised. A proportion of the share capital was converted so that those shares held by two founder shareholders became deferred shares. As such, these shares were subordinate to the ordinary shares on a winding-up.
Unfortunately, the result of such actions, meant that HMRC considered that the ordinary shares breached one of the conditions set out in the EIS legislation. That is that they did not meet the requirement that they should not carry any present or future preferential right to the company’s assets on a winding-up.
HMRC therefore refused to authorise the issue of EIS compliance statements.
It was argued on behalf of the company that because the maximum entitlement of the ordinary shareholders was to repayment of nominal value of £933 in priority to the repayment to the deferred shareholders of nominal value of £150 yet the value of the Company was around £2.2 million, the preferential right should be ignored on two grounds.
First, a purposive approach to legal construction led to the conclusion that the ordinary shares were of the kind parliament intended to benefit from EIS relief because they carried the overwhelming majority of the risk and reward in the company’s business.
Second, on the basis of the general principle of statutory construction known as the de minimis rule, the rights would be deemed so insignificant as to be ignored.
The FTT considered that the de minimis rule had to yield to any contrary intention of the statute and therefore the true question was whether or not Parliament intended shares to satisfy the condition in s. 173(2)(aa) in spite of small or insignificant preferential rights.
As the legislation is both lengthy and detailed, the Tribunal concluded that if this had been Parliament’s intention it would have been expressly legislated. Consequently the taxpayer’s appeal was dismissed.
As well as illustrating that the qualifying conditions are extremely complex for EIS and Seed EIS it also shows an asymmetry in the concept of fairness in the tax system.
After all, EIS was introduced to encourage investment in smaller growth companies. The reliefs being provided to compensate the individual investor for the undoubted risk her is entering in to. For relief to be denied in circumstances such as these seem rather inequitable.
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