What happens if SEIS/EIS conditions are broken?
If conditions are broken within the 3-year qualifying period, investors lose their tax relief and must repay it to HMRC. The company may also face consequences including being unable to issue further SEIS/EIS-qualifying shares. The clawback affects all investors in that share issue.
Detailed Explanation
Consequences of breaking SEIS/EIS conditions
The SEIS and EIS qualifying conditions must be maintained for 3 years from the date the shares were issued (the 'qualifying period'). If conditions are broken during this time, the tax relief is clawed back.
What triggers a clawback?
Common events that break conditions include:
1. Company ceases to qualify
The company stops carrying on a qualifying trade, begins an excluded activity as a substantial part of its business, or becomes controlled by another company.
2. Share disposal within 3 years
If an investor sells, transfers, or otherwise disposes of their shares within the qualifying period, the income tax relief is withdrawn.
3. Value received by investor
If an investor receives value from the company (beyond normal dividends on non-preferential terms) during a restricted period around the share issue, the relief may be reduced or withdrawn. 'Value' includes loans, excessive payments for goods or services, and asset transfers at undervalue.
4. Connected person rules breached
If an investor who claimed EIS relief becomes a director or employee within the qualifying period, or their shareholding exceeds 30%.
5. Company listed
If the company becomes listed on a recognised stock exchange during the qualifying period.
6. Share reorganisation
Certain share reorganisations or bonus issues that alter the original investment structure.
What the investor loses
- Income tax relief
Must be repaid to HMRC. For EIS, this is 30% of the original investment. For SEIS, 50%. This is collected through Self Assessment. - **CGT exemption
The repayment process
HMRC will issue a notice to the investor requiring repayment of the relief. The amount is added to the investor's tax liability for the year in which the condition was broken. Interest may also be charged.
Impact on the company
- The company may lose its ability to issue further qualifying shares under SEIS or EIS
- Reputational damage with the investor community
- Potential liability to investors who lose their relief, depending on the terms of any investment agreement
- Many investment agreements include warranties that the company will maintain qualifying conditions, with indemnity provisions if these are breached
Partial breaches
In some cases, only some investors in a round may be affected. For example, if one investor becomes a director (breaching the connected person rule), only their relief is withdrawn. Other investors in the same round are unaffected, provided the company itself still qualifies.
What to do if conditions might be broken
- Seek professional advice immediately before taking any action that might affect qualifying status
- Notify investors of the potential issue
- Consider whether the action can be delayed until after the 3-year qualifying period
- If the breach is unavoidable, help investors understand the tax consequences and timeline for repayment
Source: HMRC VCM14120 - Withdrawal of EIS Relief
Real-World Examples
Change in Qualifying Trade
Tech Startup Ltd. received SEIS investment to develop a new AI platform. After 18 months, they pivoted to providing IT support, which is not a qualifying trade. Investors who claimed SEIS relief on their Tech Startup Ltd. shares will have to repay the tax relief they received.
Acquisition by a Larger Company
Green Energy Solutions Ltd. secured EIS funding to expand their renewable energy services. Two years later, they are acquired by a large oil and gas conglomerate. This change in control, impacting Green Energy Solutions Ltd.'s independence, triggers a clawback of EIS relief for the investors.
Exceeding Gross Assets Limit
Software Solutions Ltd. initially qualified for EIS funding with gross assets under £15 million. Eighteen months later, due to rapid growth and revaluation of their assets, the gross assets exceed the limit. This breach of the ongoing conditions leads to a loss of EIS relief for investors.
Common Mistakes to Avoid
- Failing to monitor ongoing compliance with SEIS/EIS rules after the initial investment is received.
- Assuming that a minor alteration in the business plan will not affect SEIS/EIS eligibility.
- Not informing HMRC promptly about events that might cause a breach of the SEIS/EIS conditions, resulting in penalties and accrued interest.
- Distributing value (other than insignificant amounts) to investors during the qualifying period can disqualify the investment from SEIS/EIS relief.
Frequently Asked Questions
What happens if only *some* investors break a condition, e.g., by selling their shares early?
If an individual investor sells their shares within the three-year qualifying period, *that investor* will lose their tax relief and have to repay it, but it doesn't affect the relief claimed by other investors in the same share issue.
If the company breaches a condition, how does HMRC find out?
HMRC relies on the company to self-report any breaches of the SEIS/EIS conditions. Failing to do so can result in penalties and further scrutiny. You must inform HMRC within 60 days of becoming aware of the breach.
Can a company re-qualify for SEIS/EIS after a breach?
Yes, a company can requalify for SEIS/EIS if they rectify the breach and meet all the eligibility criteria again for a *new* share issue. However, this does not reinstate the tax relief for the original, disqualified investment.
Does HMRC offer advance assurance on whether a specific action will break the conditions?
While HMRC won't pre-approve every specific action, they do offer an advance assurance service for SEIS/EIS eligibility in general. It's advisable to seek advance assurance before making significant changes to the business to avoid unintentionally breaking the conditions.
What are the penalties for failing to notify HMRC of a condition breach?
Failure to notify HMRC of a condition breach within the required timeframe can result in penalties. The size of the penalty depends on the severity and duration of the failure and can include interest charges on the tax relief initially claimed.
Practical Tips
- Implement a regular internal review process to monitor compliance with SEIS/EIS conditions throughout the qualifying period.
- Before making any significant changes to the business, consult with a tax advisor or accountant to assess the potential impact on SEIS/EIS eligibility.
- Maintain detailed records of all activities related to the SEIS/EIS investment, including minutes of meetings, business plans, and financial statements.
- Ensure all directors and key employees are fully aware of the SEIS/EIS conditions and their responsibilities for maintaining compliance.
Related Questions
What records do I need to keep for SEIS/EIS?
Companies must keep records of share issues, how investment funds are spent, compliance with qualifying conditions, employee numbers, gross assets, and trading activity. Investors must keep their SEIS3/EIS3 certificates and records of when shares were acquired and disposed of.
What is the 30% shareholding test for SEIS/EIS?
The 30% shareholding test determines whether an investor is a 'connected person'. If you (together with associates) hold more than 30% of a company's shares, voting rights, or rights to assets on winding up, you cannot claim EIS tax relief. Under SEIS, you also lose relief if you exceed 30%.
Can directors invest in their own company via EIS?
Generally no. Directors, employees, and anyone who holds more than 30% of the company's shares (or voting rights or rights to assets) are 'connected persons' and cannot claim EIS tax relief. However, SEIS has a partial exception for directors of companies less than 2 years old.
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