Capital gains tax

GF010 – What trades qualify for SEIS / EIS + potential problems for software (saas) companies!

Posted on September 7, 2015 by Steve Livingston Get Funded! podcast 0

Get Funded! podcast covering SEIS and EIS

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In this episode of the Get Funded! podcast we cover the types of trades that qualify for funding under the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS).

We discuss the HMRC excluded activities list that you need to check to confirm that your proposed trade is not listed i.e. excluded. If not, then you should be okay.

There is a relaxation for these excluded activities to be included within your trade although it must not amount to a ‘substantial’ proportion of your overall trade. ‘Substantial’ for these purposes is deemed to amount to no more than 20%. The HMRC advance assurance procedure would be key in these circumstances.

We pay particular attention to the potential problem for software companies (particularly software-as-a-service (Saas) based companies) given that the receipt of royalties or licence fee income IS an excluded activity. There is a carve-out from this exclusion for companies that create the whole or greater part of the underlying asset that generates the licence or royalty fee income – most software companies rely on this exemption to qualify for SEIS / EIS – but there are some further traps for the unwary….

March Budget 2014 – Key points for Digital, tech & creative companies

Posted on March 20, 2014 by Steve Livingston Tax N2K 0

Highlights include:

Increase in payable R&D tax credit for loss-making SMEs from 11% to 14.5% for expenditure incurred on or after 1 April 2014. This means that approximately 33% of qualifying spend is eligible for a tax credit rather than the current 24.75%
Seed EIS (SEIS) turned into a permanent tax relief given its success along with the 50% CGT exemption for gains reinvested
Doubling of the Annual Investment Allowance from £250,000 to £500,000 for expenditure incurred on or after 1 April 2014 for companies until 31 December 2015. This will allow 99% of companies to get 100% write off of their investment into capital expenditure in the year of expenditure (excludes buildings and most cars).
Personal allowance increase to £10,500 from April 2015 (£10,000 from 6 April 2014) and an increase in the basic rate tax band to allow higher rate tax payers to receive some of the benefit.

Has your company missed out on EMI too?

Enterprise Management Incentive share option schemes (or ‘EMI’ for short) have long been a useful tool for entrepreneurial fast growing companies that wish to both tie-in key employees and incentivise them tax efficiently with the promise of jam tomorrow in the form of a slice of the share equity.

The peculiar thing as evidenced from the chart above is the apparent lack of take-up by start-ups and SMEs – even ignoring the flat-lining in recent years which could be attributed to the general market malay – in that only approx 7,500 companies have an EMI scheme across the entire UK…! Which begs the question:

Is your company missing out on an EMI share option scheme?

Before going any further, its worth having a brief recap on the key tax benefits of an EMI share option scheme for qualifying companies:

No income tax or NIC cost on grant or exercise of the EMI options
Growth in shares under EMI option subject to capital gains tax (CGT) rather than dreaded income tax (45% anyone?!)
Potential for Entrepreneur’s Relief for EMI option holders even though they may ultimately hold less than the normal required 5% shareholding plus the 12 months accruing from grant of the share option (a MASSIVE recent change)
Corporation tax deduction for the company on exit in most cases.

Admittedly the entrepreneur’s relief relaxations (which I have long banged on about!) are fairly recent changes; but still, the benefits are plain to see, compared to say unapproved share options which normally have income tax and NIC written all over them…!!!

Let’s not forget that for cash-strapped start-ups and early stage companies, the ability to give highly valued employees a stake in the company with no cost outlay is a huge deal especially in the current economic climate – also, note how the company can get a tax deduction (on the increase in value between the exercise price and market value) even though the company has not incurred an expense as such!

There is also flexibility as to how and when employees can exercise the EMI share options e.g. with some being structured as ‘exit only’ options (ie the EMI options vest only minutes before a sale of the company) and /or performance criteria can be included to keep the relevant employees on their toes!

So why poor take up for EMI share schemes in the UK?

Here’s my take from experience of talking to entrepreneurs about structuring tax efficient employee remuneration planning and EMI’s in particular:

Unawareness of the scheme – sad but true, many accountants have not advised their clients that such a mechanism exists to incentivise their employees tax efficiently for both themselves and the employing company.
Too complex & costly – this is normally a misconception. Okay, the rules can be cumbersome in parts and there are some strict eligibility requirements but if you work with advisers who have implemented EMI option schemes before, this should be a problem. The costs should be far outweighed by the savings – oh, and our professional costs for setting up EMIs are tax deductible!
Bad experience in a ‘previous life’ – this can be an issue where unrealistic expectations are set when the option scheme is set-up and things don’t materialise as expected e.g. no exit occurs within the expected time-frame or if it does, the gains for the EMI optionholders turn out to be fairly paltry compared to the vision painted at the outset. Sometimes the very employees who suffered at the hands of a badly communicated EMI scheme set-up are now at the helm of their own company and are understandably fearful of inflicting the same disappointment on their own team. Managed well, this should not be an issue but it does come up…
No clear exit plan – EMI’s are designed for entrepreneurial fast growing companies and, although a company can’t have an immediate sale on the cards when it sets up the scheme, it needs to have a time-frame and clear action plan for how it will allow its employees to realise the value they hold in the paper that will turn into shares. Like point 3, we’re down to managing expectations…

What’s your experience of EMI option schemes (good and bad)?

Reform needed for 5% shareholding req for Entrepreneur’s Relief

Posted on July 21, 2011 by Steve Livingston Tax N2K 1

Current tax rules require shareholders to be officers or employees of a company and hold 5% of the ordinary shares (and voting rights) for a 12 month period prior to sale to qualify for the holy grail of entrepreneur’s relief (ER) – ER results in a 10% personal capital gains tax rate (CGT) as opposed to a top rate of 28% CGT which is worth a potential £1.8m in tax savings.

I am currently encountering 3 common problems related to this condition in advising fast growth tech companies:

Founders are seeing their equity being diluted as they approach much needed successive investment rounds and may therefore find themselves sinking below the 5% threshold – what adverse impact might this have on the funding decisions of business founders?
You need to hold the 5% minimum requirement for 12 months prior to sale – what about employee shareholders who exercise share options just prior to sale (because that’s all the share option scheme permits)?
What if a Founder is willing to share equity with a number of key employees (and reach the 5% threshold in each case) but is unwilling to relinquish voting rights? Especially if say 5 or more shareholders are given 5% each thereby breaching the 75% ownership limit necessary for passing special resolutions? Although this can often be managed via a shareholder agreement, some founders may be unwilling to enforce their (perceived) rights by suing for breach of contract.

Clearly, any tax incentive worth a potential £1.8m requires conditions and safeguards but it is disappointing when these conditions lead to skewed and sometimes uncommercial decisionmaking.

What changes or improvements would you like to see made to entrepreneurs relief?

Budget 2011 must support entrepreneurs

Posted on March 23, 2011 by Steve Livingston Tax N2K 0

With a little less than 30 minutes to go until the Budget speech, I am looking forward to a pro-entrepreneur business set of proposals and actions to support growth for the future.

Looks like the Institute of Directors (IoD) are too with some of their proposals – here’s one in particular that I like:

Introducing an exemption from future capital gains tax for entrepreneurial investments. If a new company starts in business between now and 5 April 2012 then the people who subscribe for shares in it within that period would be exempt from capital gains tax when they sold those shares, whenever they sold them. This would encourage the injection of fresh equity capital into businesses (only shares subscribed for would qualify, not shares bought from existing shareholders).

If we want more private sector jobs then we need more private sector businesses.

How do you encourage entrepreneurs and business owners to take that capital risk? This is one good idea. Let’s hope George has plenty more up his sleeve!

What does Entrepreneur’s Relief mean for you as a business shareholder?

Posted on August 10, 2010 by Steve Livingston Selling your Business 0

It was nice to be quoted in today’s North West BusinessDesk.com (registration required) on why now might be a good time for entrepreneurial business owners to consider selling or exiting their business. I thought it might be useful to expand on this short published article.

You may have heard in the fairly recent Emergency Budget that the 18% flat tax rate on capital gains was increased to 28% for higher rate tax payers with effect from 23 June 2010 – the higher rate tax kicks in where total income, including capital gains, exceeds approx £43,000.

So does this mean that you might suffer tax at 28% on the gain if and when you come to sell your business?

For most hands-on digital entrepreneurs the answer should be “No”. On the sale of your business, you should (subject to the qualifying conditions below) qualify for Entrepreneurs Relief which provides a preferential tax rate of just 10% on capital gains crystallised on lifetime gains up to £5m [Note that this increased to £10m].

Compare this with the current super tax rate of 50% for earned income in excess of £150,000 [45% from 6 April 2013]. The difference between capital gains (as suffered on the sale of a business or shares in a company) as opposed to earned income is absolutely critical!

Further, the June 2010 Emergency Budget made Entrepreneurs’ Relief even better by increasing the lifetime allowance from £2m to £5m (saving a potential additional £540,000 of tax) so it is vitally important that you structure your business to take maximum advantage of this valuable tax break [Note that increased to £10m – even more important….!].

Key qualifying conditions for entrepreneur’s relief to apply to the sale of shares in your company:

You must hold at least 5% of the ordinary shares and voting power
It must be a trading company (most digital, tech and creative businesses would satisfy this condition)
You must be an officer or employee of the company
You must hold the shares for a minimum of 12 months prior to sale.

So based on these conditions, 20 employee shareholders could theoretically shelter a gain of £100m taxed at just 10%!

It is vitally important therefore that you consider the following potential opportunities and pitfalls in structuring your company shareholdings and arrangements to secure entrepreneur’s relief:

% of shares awarded – you would be seriously peeved off if you were awarded 4% of the shares and voting power if, with a little advance planning, an additional 1% could have saved you approx £800,000 in tax if the business ultimately sold out for c£100m – this is a key issue for founders to consider plus for incentivising key management
rights attached to the shares – what if you were awarded 10% of the shares of a class that held no voting rights and then found out years later on exit that you were subject to tax at 28% when your colleagues paid tax at just 10% because they all had voting rights (you didn’t think this minor omission was all that important at the start…)?
duration of the shareholding – many tax advantaged share schemes such as HMRC approved Enterprise Management Incentive schemes (EMI) used to be more valuable as, not only do they allow you to pick and choose who will be awarded share options, they also allowed for the lowest capital gains rates of 10% under the old CGT regime in pretty much all cases. Not necessarily now… Most EMI schemes are structured such that the options are exercised at the point of a sale of the company or exit, however, if this pattern of facts unfolds you would not have held the shares for the necessary 12 months. You would fail the test. You would have had to have exercised the share options and acquired the shares 12 months before the deal to qualify for entrepreneur’s relief (this assumes that you had the cash to fund the share acquisition which is often a practical difficulty in itself)
role of shareholders – there is no requirement to work a specific minimum number of hours or hold a particular post but to qualify you must formally hold a post within the company, either as an officer or employee. Non-executive directors should qualify so long as they are formally engaged – but what does this mean for many angel investors? Also, consider advance planning if you are a husband and wife company – shares can be transferred between a husband and wife (or civil partnerships) without triggering a taxable capital gain so it is sensible tax planning to consider transferring a minimum of 5% of the shares as soon as possible and ensuring that the recipient spouse carries out some role (with a title) in the business.

The key tipping point for shareholders is on gains exceeding £7.5m as this is the point at which the hike in tax rates from 10% to 28% (as opposed to 18%) but compensated for the increase in lifetime allowance to [£5m] (from £2m) really bites.

Although this is splitting hairs for most entrepreneurs as getting the most out of your business at the end given all the blood, sweat and tears suffered in building it is absolutely paramount. So don’t risk leaving it until you (and your team) are sitting on a capital gain of £8m+ before you start thinking about this stuff. Fancy a coffee?

The above information is for educational and entertainment purposes only and does not constitute professional advice. Please contact me if you would like to discuss factors specific to your circumstances or discuss with your professional adviser.

Photo credit

2010 Year End Tax Planning Tips for UK Entrepreneurs

Posted on March 30, 2010 by Steve Livingston Tax N2K 0

Given that the 5 April 2010 UK tax year end is imminent, we are busy advising our UK entrepreneurial clients on ways in which they can arrange their tax affairs to pay the right amount of tax – and not a penny more!

Here are just some of the issues we’re discussing – remember, you should seek advice specific to your circumstances as these are general points only:

For those typically earning more than £150,000 per year, the new 50% super higher rate of tax will hit hard when it is introduced on 6 April 2010. So we are advising those likely to be affected either to bring forward bonus payments or, where they are shareholders and sufficient distributable reserves exist in the company, to pay a dividend by 5 April 2010. An accelerated dividend payment is preferable in most cases as this is normally more tax efficient plus there are National Insurance savings. A word of caution – watch out for the pension anti-forestalling provisions if you are taking steps now that might increase your total income above £130,000….
From 5 April 2010, the personal allowance available to all UK individuals will be tapered away for earnings in excess of £100,000. This means that for those with income falling between £100,000 – £112,950 in the 2010/11 tax year, the effective income tax rate will be a whopping 60%! Taking steps now either to advance salary payments to pay the current highest rate of 40% or to structure arrangements to fall outside these bands will save hard cash.
Making pension contributions (either personally or via the entrepreneur’s company) can still make good financial and tax sense, however, beware of the restriction on higher rate tax relief for high earners from 6 April 2011 – in an attempt to stop savvy folk from piling cash into their pensions in advance of these measures, the Chancellor introduced some hideously complex rules called the pension anti-forestalling measures that limit higher rate tax relief on contributions for those whose income exceeds £130,000 (either now or in previous recent tax years) to £20,000 (or up to £30,000 in certain circumstances). Seek professional advice if you think you might be affected.
Consider transferring income generating assets to spouses in cases where the spouse is a non-earner. Given that every individual receives a tax-free personal allowance and a 20% tax band up to c£45k it makes sense to consider splitting income where possible – be wary of splitting dividend income in husband and wife companies where only one spouse is active in the company.
Every individual has a capital gains tax-free annual allowance of £10,100 (in 2010/11) so make use of this to crystallise gains where possible – if you don’t use it, you lose it.
The highest rate of capital gains tax is still only 18% compared to 40% (soon to be 50%) for income. Also, compare the income annual personal allowance (c£7k) with the capital gains tax allowance (c£10k). Could this influence your investment strategies going forward to favour capital growth rather than income? Beware of the time horizon though as this gaping difference is unlikely to endure for long… [Update: 22 June 2010 Budget increased highest rate of CGT to 28%]
Every individual (over 16) can invest in a tax-free wrapper called an Individual Savings Account (ISA) in which interest income on cash or capital growth and dividends on shares is tax free. Most have a £7,200 allowance to 5 April 2010 and this goes up to £10,200 from 6 April 2010. Drip-feeding savings provides the benefit of cost-pound-averaging which can provide better returns than piling in lumps sums on 5 April each year!
Many entrepreneurs are unaware that they can invest in pensions on behalf of their non-earning children and still obtain basic rate tax relief up to £3,600 – so you need only invest £2,880 and HM Revenue & Customs will kindly top it up to £3,600!
Those with furnished holiday lets that haven’t performed to expectations have a short window of opportunity to obtain business asset tax treatment on a sale of the property up to 5 April 2010 – this allows for more tax advantageous income and capital gains tax treatment but time is running short… [Update: 22 June 2010 Budget extended this opportunity for a further 12 months]
Useful additions to an entrepreneur’s investment tools include Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) which offer differing but welcomed income tax and capital gains tax benefits.

Above are just 10 tax planning ideas that we are busy discussing with our entrepreneurial and family owned business clients. Hopefully your accountant is doing likewise. If not, please contact me and we can discuss your specific circumstances.

Take steps NOW to review your tax position. Time is running out for the 5 April 2010 tax year!

The above analysis is a general summary of some tax planning opportunities available for UK individuals in the run up to 5 April 2010 and should not be relied upon. Please seek professional advice specific to your circumstances.

Photo credits – Roll the dice

UK Innovation Investment Fund – Too little, too late?

Posted on March 1, 2010 by Steve Livingston Tax N2K 0

Launch of the £200m UK Innovation Investment Fund could not come at a better time as funding for early stage technology, digital and life science companies continues to dry-up – worrying given that these are the innovative fast growth companies that our UK economy is relying on to dig us out of our UK budget deficit. Dow Jones VentureSource estimates that venture fund-raising for investment in early stage tech companies is down from 210 in 2005 to just 86 in 2010.

Although news of this additional funding is good for entrepreneurs and start-up ventures, there is a risk that it could be a long while before the cash trickles down to the fledgling businesses that need it most – like now! In the meantime, it is predominantly more adventurous private investors who are picking up the slack. A welcome form of microfinancing by microangels, perhaps?

Rather than relying simply on showering (further) State Aid, I do believe that we need to think more adventurously about introducing further tax incentives for our exciting and innovative new start-ups. This could also provide further stimulus for smaller (but welcomed) financing from private investors who can match the risk against tax incentives even with smaller (micro)investments.

Consider that there is currently no difference in UK capital gains tax payable between selling a property or shares in a start-up company as an external investor (CGT rate of 10-18%). Does this accurately match the risk / reward? I think not.

Consider also that there are murmurs of a Conservative government removing the highly valuable R&D tax credit incentives in order to simplify the corporation tax main and small company rates – where is the incentive to break the mould and create game-changing businesses under this policy?

At least announcements were made in the Pre-Budget Report that we should see a lower rate of corporation tax for patent income but this is delayed until 2013 at the earliest – this is assuming it doesn’t get derailed prior to implementation in the same way that the Broadband Tax might (see further below)!

We need more support for UK innovative businesses. We need it now.