Introduction

We welcome Minister Donohoe’s initiative to explore the impact of the pandemic on private investor confidence and availability of private equity investment in Irish companies.

The EII scheme has evolved in recent years. The scheme is no longer subject to the high-income earner restriction, investors can claim income tax relief of 40 percent on a subscription for eligible shares on or after 9 October 2019 and the Start-Up Capital Incentive scheme facilitates (limited) investments by family members. However, the 2014 revision of EU General Block Exemption Regulation (GBER) for State Aid has significantly restricted the scope of the EII scheme and its effectiveness as a workable tax relief. GERB was incorporated into Irish tax law under Finance Act 2015 and the statistics on the value and number of EII claims since its introduction is an indication of the negative impact of the restrictions.

Enhanced support for start-ups through EII

EII is needed more than ever to meet a market gap in accessing finance for early-stage companies and for SMEs seeking to raise equity capital for major expansions in their business. However, the design of the current EII scheme continues to be very complex and costly for SMEs to use as a means of raising funding. Many worthy SMEs cannot overcome such obstacles and consequently lose out on this important tax relief.

Risk with self-certification

Finance Act 2018 introduced self-certification for qualification for EII scheme purposes on both the company and the investor. Self-certification makes it more difficult to secure new investors and reduces the likelihood of retaining existing investors because investors perceive that they face greater uncertainty that relief they claim will be clawed back if an issue should arise with self-certification.

A great deal of additional financial risk also comes with self-certification for a start-up operation or small-scale company already exposed to high risk. For example, if a company makes an incorrect statement of qualification, as per the tax legislation, the company is liable to corporation tax on an amount 1.2 times the relief given or such part of that amount that does not qualify for relief. A high degree of interest exposure also arises in the case of a claw back of relief due to an incorrect certification along with penalties. This risk is separate to the risk of an investor not meeting conditions for the relief. The investors must also certify that they have met the various investor conditions, and relief is clawed back from the investor if he/she incorrectly self-certifies.

The risk inherent in self-certification can be alleviated to some degree if companies have access to experienced Revenue personnel to help with the application process. It is essential that adequate resources are available to Revenue to provide trained staff who understand the complicated rules of the scheme and that staff are contactable and available to respond to queries in a timely manner.

Unrestricted CGT loss relief

To counter the impact of the restrictions imposed by GBER and the additional risk of self-certification, the capital gains tax treatment of losses on EII investments should be revised. For example, a capital loss arising on the disposal of EII shares should be available for offset against other gains arising to the investor in addition to the income tax relief he/she receives on making the original investment. Indecon’s 2018 EIIS/SURE report to the Government supported unrestricted CGT loss relief for investors.

The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are two of a number of UK Government initiatives which encourage innovation by granting private investors a significant tax break when investing in early stage, high-risk companies. The EIIS should incorporate the best of the UK scheme measures to enhance the Irish scheme.

The tax incentives available to investors under the UK’s EIS/SEIS include:

• A capital gains tax exemption applicable to 50 percent of gains up to a maximum of £50,000 reinvested in SEIS shares.
• Income tax relief at 50 percent of the cost of the shares, on a maximum annual investment of £100,000.
• Tax free disposal of SEIS shares held for more than 3 years.
• Losses on SEIS shares held for more than 3 years can be offset against other income.

The EIS and SEIS reliefs are fundamentally a suite of reliefs which cover the lifecycle of investments in SMEs, from an upfront income tax relief on purchasing the shares, a tax exemption on sale of the shares, to capital gains tax relief aimed at encouraging further EIS investment and tax relief on possible losses arising on the disposal of the shares.

Tax relief for equity investment by company founders

Apart from micro-companies qualifying under the start-up capital incentive, company founders and connected parties are generally precluded from claiming tax relief under the EII. This restriction closes the door on tax relief for the traditional early-stage investor and an alternative tax measure is necessary to encourage investment for start-ups who face very limited finance options at inception.

Founders and connected parties of start-up SMEs could benefit from a reduced rate of income tax on dividends paid by their companies once the company has been trading for a set period of five years, for example. This incentive would encourage the founder and his/her friends and family to invest equity on a new start-up, retain funds in the company for growth and development during the start-up phase and provide a mechanism for a tax efficient reward in return for risk while still retaining shares and ownership of the company.

Capital redemption window

A company can redeem shares from members other than an EII investor who is within their compliance period without triggering a clawback of EII relief under section 508R TCA 1997. Where the company or any company in the RICT Group returns capital to EII investors within their compliance period it will result in a clawback of relief from those investors.

This means that individuals with multiple investments or a connected party cannot utilise the capital redemption window. This restriction impacts follow-on investment and capacity to raise funds as companies are forced to fundraise with separate investment groups. The restriction also blocks follow on investment from designated investment funds due to the risk of repeat investors and/or connected parties participating in the funds.

Statement of qualification

A company can only issue a statement of qualification once 30 percent of the EII scheme funding is spent on a qualifying purpose. This requirement places a significant administrative burden on early-stage companies in tracking expenditure and it also reduces the attractiveness of EII schemes due to the lack of clarity on when the investor can claim tax relief. A statement of qualification should be issued once an investment has been made in a qualifying company.

How EII might respond to the changing environment in which it operates

Given the uncertainties brought about by Covid-19, the challenge faced by SMEs raising equity finance and the risk to investors is even greater than before. We set out several measures to support the EII investment proposition considering Covid-19 disruption:

• Increase tax relief to investors in recognition of the higher risk of making an investment in the uncertain pandemic environment.
• The seven-year rule for RICT Groups under GBER could also be relaxed to allow SMEs more than seven years to access EII generated equity funding without the need to launch either a new product or enter a new market.
• Founders (and/or connected parties) could be given tax relief to encourage investment by them or their connected parties in the SME.
• The tourism sector has been particularly adversely impacted by the COVID-19 restrictions. The pre-condition of Fáilte Ireland approval should be relaxed to make it easier for businesses in the sector to apply for the scheme. Indecon also recommended that Fáilte Ireland approval be abolished.
• Businesses selling knowledge and expertise such as recruitment businesses, management consultancy businesses, marketing and PR businesses are equally capable of providing job opportunities but are excluded from the EII. The financial model of professional service companies is based on running the business on an overdraft or loan. These companies have many uses for outside investment which would be used for equally worthy purposes as with other trading companies who can benefit from the EII. The EII should be expanded to allow for investment in service businesses.

The Start-Up Capital Incentive (SCI)

The SCI is an under-utilised tax relief which would benefit from a public awareness campaign to promote it as a viable means of funding.

The SCI is open to investors connected to the original shareholders only in the case of early-stage (less than two years old) micro companies. Given the importance of personal networks when small businesses are raising finance in start-up and in expansion or pivot phases of a business, connected investors should be allowed access to tax relief for SCI investment in all micro and small businesses at any point in their lifecycle. In addition, the €500,000 investment limit is restrictive and could be increased to €1 million.

Start Up Relief for Entrepreneurs (‘SURE’)

Unfortunately, the COVID-19 crisis has given rise to redundancies. SURE can provide support to individuals who decide to set up their own business. Simplification of the application process would do a lot to improve access to this valuable source of funding for start-up businesses, along with a public campaign to raise awareness of the scheme’s existence.

Potential to attract capital from a broader range of investors

The appeal of EIIS investments would be greatly enhanced by allowing other investment vehicles, such as private equity partnership, to qualify for tax relief on EIIS investments. Increasing the range of collective investment structures which can access EIIS tax relief will generate funding for SMEs facing liquidity challenges so pervasive at this time.

1 Revenue Costs of Expenditure statistics (https://www.revenue.ie/en/corporate/information-about-revenue/statistics/tax-expenditures/costs-expenditures.aspx)