Tax tribunal case highlights the complexity of EIS, warns Haslers Chartered Accountants

The experienced tax team at Haslers Chartered Accountants in Loughton are encouraging investors to seek advice after complex share arrangements prevent shareholders benefitting from important tax relief.

In the recent First Tier Tribunal (FTT) case, Foojit Ltd v HMRC [2019] TC7467, shareholders of Foojit Ltd lost a claim for Enterprise Investment Scheme (EIS) relief on shares with complex preferential dividend rights.

EIS is a much sought-after initiative that allows shareholders to enjoy tax relief of 30 per cent on the cost of the shares, which is offset against their Income Tax liability for the year in which the investment is made.

To benefit from the relief, qualifying shares must be issued to a qualifying investor. Qualifying shares must be ordinary share which, at the time of issue and for the following three years, do not carry any present or future preferential right to dividends, preferential right to the company’s assets on a winding-up, or right to be redeemed.

In the case of Foojit, it hoped to issue shares to raise investment funding and wanted the new shareholders to have enhanced protection against the company’s existing shareholders.

In its company articles, it amended the rules so that the new shareholders had a right to a prior dividend of 44 per cent of the available distributable profits, “which may not be altered by resolution of the board of directors or the members”.

To make the investment scheme more attractive it sought an advanced assurance from HM Revenue & Customs, which was granted.

However, HMRC refused to issue EIS compliance certificates on the basis that the new shares carried an excluded preferential right within the relevant three-year period.

Foojit appealed the decision saying was that shares with preferential rights are only excluded if the preferential right is one whereby, “the amount of any dividends payable pursuant to the right, or the date or dates on which they are payable, depend to any extent on a decision of the company, the holder of the share or any other person”

However, the FTT dismissed the appeal finding that the new share did have preferential rights within the Companies Act (s173(2)(a) and therefore the shares did not qualify for EIS relief.

Paul Reynolds, Tax Partner at Haslers, said: “This case was very complex and there was a lot for the judge to consider. During the tribunal, the judge pointed out that the EIS rules are very prescriptive and that there was no room for ambiguity when applying them or seeking preferential rules outside of what was allowed under the Companies Act.

“EIS relief is based around a strict set of rules and it can be easy to stray outside of these due to a simple error or oversight. Those looking to make use of EIS should, therefore, seek out expert assistance to ensure that shareholders can benefit fully from the tax relief available to them.”