Fluidity Films is grateful to Wiggin LLP and whatinvestment.co.uk for the following explanation of S-EIS and EIS in the film sector.

 

NB. Fluidity Films has no commercial connection with either company and this is to be used as a guide only and is not an invitation to invest. Potential investors should always discuss investments with their financial advisors. Film investment is a risky activity and you may not receive back what you originally invested.

 

Overview of EIS

• The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) are government initiatives offering some of the most attractive tax breaks available in the UK.

• To access them, you need to invest in the shares of a small, unlisted company. Small means 250 employees or less, and maximum gross assets of £15 million (before the investment). Unlisted means that the company is not quoted on a major stock market, although it can be quoted on a market for smaller companies like AIM or ISDX.

• Obviously, investing in small companies is generally riskier than buying shares in giants like HSBC or Shell. And the fact that the companies are not listed on the stock market means that there’s no easy way to sell your shares.

• But small companies can grow very quickly because they are coming from a low base. With a small company, you’re more likely to lose your money, but you’re also more likely to make double, treble, or an even bigger multiple of the amount you invested.

 

Enterprise Investment Scheme (EIS) tax breaks

• You get income tax relief of 30 per cent. So if you invest £10,000 in a company that is eligible for EIS, you can knock £3,000 off your income tax bill in the year that you invest.

• You’ll pay no capital gains tax on any profits you make from an EIS investment. So if you invest £10,000 and five years later sell your shares for £20,000, you’ll get the full benefit of the £10,000 profit, saving you at least £1,800.

• If you make a loss on your investment, you can offset that loss against income tax. So let’s say you lose your entire £10,000 investment. Because of income tax relief, your actual loss is only £7,000 (£10,000-£3,000). So you can, if you choose, reduce your taxable income for the year in which you disposed of the shares by £7,000, resulting in a saving of £2,800 (40 per cent of £7,000) for a higher-rate taxpayer. If you want to offset your loss against other capital gains in the normal way, you can do this instead.

• There’s no inheritance tax to pay on shares bought through EIS.

• An “active trade” is needed: special rules allow licensing of intellectual property. So EIS is available for most projects in the film industry (from pre-development through production and on to distribution), along with games/app development and music recording

• Investors with stakes greater than 30% or who are employees/directors do not normally qualify

 

To be eligible for these reliefs, you generally have to hold the shares for at least three years before selling them.

 

There are a few more catches. You still have to pay tax on any dividends – but most small private companies won’t pay dividends anyway. There are certain restrictions as to what kind of business you can invest in (it can’t be a bank, a farm or a nursing home, for example). And you can’t be connected to the company or have a stake of more than 30 per cent of it.

 

You can invest a maximum of £1 million each year through EIS.

 

Outline of Scheme Rules

Throughout its relevant three-year qualifying period, the EIS company must:

• Be an unquoted company (Note: The UK AIM market is “unquoted”)

• Be a trading company, carrying on a qualifying trade

• Exist for genuine commercial purposes, and not be part of a scheme for the avoidance of tax

• Not be a 51% subsidiary of another company, or otherwise under the control of another company

• The company must not be in “financial difficulty”

• The company must have a permanent establishment in the UK. Historically it had to have its business wholly or mainly carried on in the UK so the relaxation of this requirement permits EIS relief for non-UK operating companies (e.g. in the US or elsewhere)

• In addition:

• An investor cannot be ‘connected’ with the EIS company – i.e. broadly cannot own more than 30% of the shares/votes, directly or indirectly

• Individuals who are paid directors or employees of the EIS company at the time of the issue of shares are normally disqualified from claiming EIS relief. Otherwise, qualifying investors can, in certain circumstances, be paid for their work provided that the total remuneration package is reasonable

• The money raised by the EIS share issue must be wholly used for the qualifying business activity within a 2-year period

• Schemes that underwrite the equity risk, e.g. guarantees or exit arrangements, will not attract tax relief

• To prevent abuse, there is a “no disqualifying arrangements” rule. Thus, the scheme will not attract tax relief if the shares are issued in connection with artificial arrangements whereby the EIS company is effectively a hive-off of a larger pre-existing enterprise or a mere shell lacking risk and substance. However, HMRC have assured Wiggin LLP that this rule is not intended to catch genuine commercial arrangements in the film and creative industries. Moreover, the rules should not prevent the normal film industry practice of setting up an SPV to make the film, or typical “sub-contracting” arrangements.

 

Seed Enterprise Investment Scheme (SEIS)

 

To complement EIS, since 6 April 2012 SEIS offers smaller early stage companies a similar scheme to EIS.

 

• Income tax relief of 50% of the investment for individuals who invest in qualifying companies, irrespective of their marginal rate tax

• Annual investment limit of £100,000 per individual; cumulative limit of £150,000 over 3-year period for company

• While the maximum workforce and gross assets allowable under EIS are 250 staff and £15 million respectively, SEIS has lower limits of 50 staff and £200,000 gross assets. Businesses must also be less than two years old (there are no age restrictions under EIS).

• Funds raised must be for genuine “new” (i.e. less than 2 years old) trading venture. Relief not denied if trade is never commenced – so SEIS helpful for exploratory projects (e.g. film development or games/apps creation)

• Most of the EIS restrictions (e.g. unquoted, independence, no exit/guarantee arrangements) apply equally to SEIS.

• As with EIS, there’s no capital gains tax to pay on profits, no inheritance tax, and you can claim loss relief in the same way. See above for details.

• There is an extra relief called capital gains reinvestment relief. This is useful to you if you have recently paid capital gains tax on other investments. You can reclaim up to 50 per cent of the tax paid if you reinvest that money into SEIS. (This was originally introduced as a temporary measure, but in the 2014 Budget, chancellor George Osborne made it permanent.)

 

The tax reliefs available through SEIS are so generous that for the 2012/13 tax year, they added up to a potential 100.5 per cent of your investment in a situation where that investment was a complete failure. In other words, you literally could not lose provided you had paid enough tax to offset your SEIS investment against.

 

However, for the 2013/14 and 2014/15 tax years, the downside protection has fallen 86.5 per cent – so you’ll get back £8,650 from a £10,000 investment that totally fails if you pay enough tax to use all the reliefs. This is still an excellent buffer, of course.

 

Conclusion

The EIS and SEIS schemes have gained particular popularity in the film sector – offering not only the upsides of income and capital gains tax reliefs but also downside mitigation.  Historically, EIS players could be divided into those that are genuinely aiming to recoup large returns for investors specialising in new entrepreneurial businesses and those playing as risk-free a strategy as possible to preserve capital and convert the 30% tax relief into a fixed return over the 3 year play. 

 

As mentioned, the UK Government perceived that certain schemes lacked substance and risk and have tightened the rules from April 2012 so that only genuine small entrepreneurial businesses qualify rather than hive-outs from large existing businesses.  More care is now needed in structuring schemes, but EIS/SEIS funds will nevertheless continue to provide valuable resources to the UK film sector.  The SEIS scheme will be an important tax relief attracting smaller investments into risky start-ups.