Investors love the Seed enterprise Investment scheme (SEIS) because of the generous tax breaks – but what happens if the business goes bust?
The terms of SEIS say investors must hold their shares on the start-up company for three years to qualify for the tax incentives.
But some special rules apply if the company goes to the wall before the deadline.
This much less widely known benefit is loss relief.
The relief is simple – if the company goes bust and the shares are sold at a loss, which they surely will be, loss relief kicks in to let the shareholder/investor offset the loss against income tax or CGT.
Investors must take some risk
Loss relief is not designed to replace an investor’s entire stake in a business.
HM Revenue & Customs believes the investor should hold some risk in a SEIS start-up, so only covers part of the loss, but it’s still a significant amount.
Linked with the ingoing 50% income tax relief, the two benefits safeguard the initial investment according to the marginal rate of tax the investor pays.
Investors can claim the relief against their current tax bill or carry-back the claim back a year.
Although the legislation is not clear on how loss relief works in the SEIS tax incentive qualifying period, HMRC has tried to clarify the issue for worried investors.
“If a company is wound up for genuine commercial reasons the tax relief should not be withdrawn,” said a spokesman.
Calculating loss relief
So how does loss relief work?
If someone invests the maximum £100,000 into SEIS, the initial income tax relief is £50,000, leaving £50,000. That is 50% relief against the level of the investment.
If the company goes bust and the shares are now worth nothing, loss relief is applied according to the investors marginal tax rate, so an investor paying income tax at the additional rate would receive loss of relief of £22,500. This is calculated as 45% of £50,000.
The investors unrelieved loss is £27,500.
A higher rate taxpayer (40%) would get £20,000, leaving an unrelieved loss of £30,000.