Two recent Tax Tribunal decisions have clarified when money can be said to have been 'employed' by an E.I.S. company, thereby meeting one of the qualifying rules for capital raised through the issue of new shares under the Enterprise Investment Scheme.
The two Enterprise Investment Scheme cases in question were Skye Inns + Mr C Richards v HMRC (Upper Tier Tribunal, 2011) and Benson Partnership Limited v HMRC (First Tier Tribunal, 2012). In both Tribunals, Revenue & Customs successfully argued their case.
Both the Benson and Skye Inns cases relate to an earlier set of the EIS rules which had more stringent tests for when a company needed to 'employ' the money raised. Previously, the requirement was for at least 80% of the share capital raised to be 'employed' within 12 months and any remaining funds 'employed' within 2 years.
Even though EIS rules have changed, Skye Inns & Benson Partnership are relevant on the basis that there is still a need to 'employ' money within a specified period.
In the case of Skye Inns, Christopher Richards subscribed for 3 tranches of shares in a company which proposed to operate pubs. Skye Inns used the money from the first 2 tranches to buy two public houses and HMRC accepted that in these cases EIS qualifying conditions had been met. Mr Richards' 3rd subscription in December 2001 was for about £1.5 million of shares. Skye Inns had intended to use this money to acquire yet another public house, but the proposed purchase fell through and they could not find a suitable alternative. Therefore they deposited the money in a separate account, spending half within a year on improvements to its existing public houses and some more cash on meeting trading losses incurred by the pubs.
This meant that there was a 30% shortfall in complying with the EIS requirement for 80% to be 'employed' within 2 years. Skye Inns sought to bridge this gap by arguing that its remaining funds had been employed by virtue of being earmarked for future improvements to its pubs and/or meeting future losses of the company.
The Tribunal accepted that the money actually spent had been 'employed' for EIS purposes. The Tribunal also recognised that 'employing' money for the purpose of a qualifying business activity was a wider concept. This included 'earmarking' money for a specific purpose (which did not necessarily have to be a purpose requiring expenditure in a specific period) and keeping money in reserve for that purpose.
It was down to a question of fact as to whether money had been set aside with sufficient precision for a specific purpose. Could it be said to have been 'employed' in the requisite sense? Skye Inns was unable to demonstrate, as a matter of fact, that it had 'earmarked' funds with sufficient precision. The evidence did not reveal any clear intent to set aside funds for a specific purpose. In fact, a significant cash balance had been retained for over two years after the share subscription.
Enterprise Investment Scheme relief was therefore withdrawn.
In the Benson case, the company provided a consultancy and advisory service on construction projects. In 2004 it agreed to manage the building of a dwelling and hired another company, Lebeau, to undertake construction work. Benson would pay fixed amounts to Lebeau once specific construction milestones had been reached.
It was common ground between Benson Partnership & HMRC that at least 80% of the E.I.S. money had not actually been spent within 12 months. Because of the decision in Skye Inns, Benson Partnership argued that at least 80% of the share money had nevertheless been 'employed' within 12 months. Construction had progressed to the point where Benson Partnership was liable to make payments to Lebeau and had earmarked sufficient funds to meet the liabilities and the 80% test.
The Tribunal accepted that once agreed construction milestones had been reached, Benson Partnership became liable to make payments to Lebeau and at that point in time, a stage payment could be said to have been 'earmarked' (and hence 'employed'). However, the Tribunal was not satisfied that the project had progressed sufficiently for enough stage payments to become due; or that Benson had 'earmarked' any funds for payment to Lebeau. Benson Partnership had not accrued liabilities in its accounts, and there was no other evidence of 'earmarking'.
Enterprise Investment Scheme tax relief was therefore denied.
Little comfort as it may be to the two taxpayers involved, decisions in Skye Inns and Benson Partnership provide other companies with some flexibility in spending Enterprise Investment Scheme funds. It is now clear that a company need not actually SPEND all the money raised from the issue of EIS shares within 2 years.
That money could still be 'employed' for a qualifying business activity...if it is precisely 'earmarked'. This spares Directors from the unenviable task of spending money within 2 years to satisfy EIS tests, whether or not such expenditure is prudent. Instead, money could be precisely 'earmarked' for a specific commercial purpose, with the likelihood of still being 'employed' for EIS purposes.
Although it will ultimately be HMRC's interpretation of fact whether a company has 'earmarked' money with sufficient precision, the following steps should be taken:
(1) Funds 'earmarking' to be recorded in Board minutes;
(2) Company accounts to incorporate the 'earmarking';
(3) EIS money should be deposited in a separate account. Even when all the above measure have been applied, it is worthwhile advising HMRC, in writing, of the proposed use.
Remember that HMRC have the benefit of hindsight in considering whether the EIS requirements have been met. It will therefore be prudent for any set-aside funds to actually be spent within a reasonable period of time.
In Skye Inns, the fact that there was insufficient evidence of money being spent in a commercially sensible time was one reason that the taxpayer failed in his appeal.
In the case of Benson Partnership, the Tribunal also considered whether Bensons carried on an Enterprise Investment Scheme 'qualifying trade'. This means trading on a commercial basis with a view to the realisation of profits, but excluding certain types of proscribed activity. 'Property development' is one such proscribed activity; this being the development of land by a company which has, or at any time has had, an interest in the land. Despite HMRC's submissions to the contrary, the Tax Tribunal concluded that Bensons had not engaged in 'property development', as it had no interest in the land on which Lebeau was carrying out construction work.