How does poor Financial Health affect a company’s SEIS & EIS eligibility?
Since their introduction, the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) have helped fledgling businesses raise finance from investors. To assist applicants when navigating through these often complex and convoluted qualifying criteria, HMRC regularly updates its guidance and guidelines in relation to these two investment schemes.
Recently, HMRC have introduced welcome clarification in relation to the Financial Health Requirement for SEIS and EIS. In this article we will look at the key changes made by HMRC and address how the updated guidance affects applicants.
What is the Financial Health Requirement and why is it important?
Under the Finance Act 2017, a company must be in good financial standing in order to qualify for and obtain incentive tax reliefs. The applying company must not be “in difficulty”.
In defining whether a business is “in difficulty”, HMRC will look at whether it is reasonable to assume that it would be regarded as “a firm in difficulty”. The European Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty states that a firm is in difficulty where it is unable, whether through its own resources or with the funds it is able to obtain from its owner, shareholders or creditors, to stem losses which will almost certainly condemn it to going out of business in the short or medium term.
Additionally, where a company is raising funds outside of its initial investing period, it will also be regarded as being in difficulty if more than half of its subscribed share capital has disappeared as a result of accumulated losses. This is the case when deduction of accumulated losses from reserves leads to a negative cumulative amount that exceeds half of the subscribed share capital.
As a means to protect investors, the Financial Health Requirement ensures that insolvent companies cannot obtain further investments and only genuine companies can use the schemes.
Key Changes to the HMRC Guidance
In August 2023, HMRC updated their Venture Capital manuals in relation to the Financial Health Requirement.
HMRC clarified that they will take into account the conditions set out in the Insolvency Act 1986 to ascertain whether a company is “in difficulty”. In determining this, HMRC will look at the criteria set out below:
- whether the company is unable to pay its debts as they fall due (known as the “cash flow test”); and
- whether the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (the “balance sheet test”).
The starting point when determining whether a business’ financial health is adequate is the company’s annual accounts and whether the company’s finances are caught in the above tests.
However, in its updated guidance, HMRC have confirmed that they will also consider “any reasonable adjustments” that are made to the company’s accounts which could impact the Financial Health Requirement test. HMRC provide an example of a reasonable adjustment in relation to R&D costs being treated as an asset on the company’s balance sheet, as opposed to being included on the income statement as an expense of the company. In the past, businesses have been refused access to investment schemes due how their accounts have been prepared. This has now been clarified as part of the updated guidance.
HMRC will now consider a company’s current financial health and allow for reasonable adjustments when deciding if it meets the Financial Health Requirement. HMRC have also clarified that the Financial Health Requirement must now be met by the applying company at the beginning of “Period B”, i.e., the date that the shares are issued on.
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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited 2023.