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EIS and SEIS are two of the most valuable tax relief scheme methods of support that businesses can receive, but there are strict guidelines on how they must be reported to HMRC.
There are a number of different elements which dovetail into EIS and SEIS which need special consideration, like the option of Advance Subscription Agreements. Below is a closer look at the guidance from HMRC on the subject.
What is an Advance Subscription Agreement (ASA)?
An Advance Subscription Agreement (ASA) is commonly found in startups among companies who want to raise capital without acquiring any actual debt. While it is possible to take a loan, there needs to be a cash repayment - plus interest - which may put the loan out of the reach of fledging firms.
An ASA is an alternative to borrowing although technically it is a type of equity, and not a debt. An investor purchases shares in advance which they will receive at a later date. It is not the same as a plain share purchase as the shares are not yet available, nor allocated.
It is common for the shares to be provided during the next round of funding, typically when a funding target has been attained. A long stop agreement is included as part of the deal which means that if the shares have not been issued within six months because the funding target has not been reached, they will automatically convert. This means an investor knows the maximum amount of time they must wait for their shares is six months.
An ASA can be compared to a convertible loan note, apart from the fact that it cannot be repaid in cash. A company cannot use an ASA as a mean of raising capital, only to decide to cancel the shares and repay the investment when their finances improve.
There are a number of advantages for an investor who chooses an ASA. The shares are typically issued at a pre-agreed price which is a discount plus they still qualify for SEIS and EIS tax relief when they are finally issued. This can only be done if the agreement is properly structured from the start.
HMRC Guidance
HMRC has issued guidance on how an ASA must be treated in relation to an EIS or SEIS.
An ASA is used to raise money quickly when required so it is anticipated that the terms relating to an EIS will not be complicated. If the terms of an ASA for an EIS are made to be complex, or there is a long period between the ASA and the issue of the shares there is a strong possibility that the criteria for tax relief will not be met.
The ASA must not be created to deliver other benefits, such as protecting investors. To meet all the criteria for a tax-efficient ASA, it must have been created solely for the purpose of raising funds in anticipation of the shares being issued. This must also be for the purpose of growth and development of the company.
Payment of the ASA must not constitute a loan in any way and should either part or all of the ASA be used to convert into another type of obligation or debt, then it will fail to be recognised as a valid ASA.
As part of the creation of an ASA, the company will need to be able to show how the timing of the ASA fits into a wider plan of development and growth.
To qualify as a valid ASA, the following must be fulfilled:
- The subscription payment cannot be refunded, regardless of circumstances
- There is no interest charge
- The agreement cannot be varied, cancelled or assigned
- A reasonable long stop date must be specified which typically must be no longer than six months
The long stop date is a new announcement from HMRC and something that companies must pay strict attention to. As the creation of an ASA should be strictly tied to the growth plans of a company, HMRC believe that issuing shares later than six months may indicate that the ASA is not fulfilling its initial purpose.
If a company is planning on applying for SEIS or EIS advance assurance from HMRC, the application should include the ASA if available or at least to notify HMRC of their potential use.
Potential Pitfalls
The recent clarification from HMRC will be helpful for companies who are hoping to create an ASA and are keen to avoid falling foul of potential pitfalls. By making their expectations clear, companies should now be in a much better position to ascertain whether their planned ASA meets the terms HMRC demand.
However, the six-month period is one which may be particularly problematic for some companies, especially when the next round of share allocation is not planned for another 12 months. Equity financing often takes place at intervals less frequent than six months, but HMRC have indicated that this may not be acceptable.
Other areas which could be potentially problematic are the terms of the ASA which could be misinterpreted as providing the investor with other rights. For example, certain consents over decisions or actions the company might make. Including this in an ASA might instantly disallow it under the HMRC clause which precludes investors from receiving any other rights.
The terms must also make it clear that an ASA investment is irreversible and cannot be varied, assigned or cancelled. Without this being explicitly stated, there is the risk that, again, the SEIS/EIS terms may be considered as not being properly met.
Creating an ASA can be an excellent means of raising funds for a business, without adding to the debt burden or increasing repayments but there are clearly strict conditions to be met. The new guidance from HMRC helps companies to check their ASA terms more accurately, but there are still many pitfalls. It is therefore essential to get professional advice before proceeding with an ASA for EIS or SEIS purposes.
