From start-up to sale, there are a number of opportunities to obtain tax relief that are helpfully scattered throughout the lifecycle of an IT or tech business. While these incentives could potentially enhance both a business’s development and its final profits, they’re often under-utilised simply because business owners don’t know enough about them.
The following schemes are designed to help businesses at different points in their development.
Enterprise investment scheme (EIS)
Enterprise investment schemes essentially provide tax credit for investors in tech companies. The relief is set at 30%, allowing for investments of up to £1 million in an EIS-approved company. If an investor sells their shares in the company after three years of buying them, then they’ll also incur no capital gains tax on that sale.
Investors are also covered if the venture collapses and the investment turns out to be worthless. In this instance, the investor can receive capital loss relief of around 40%, which is provided against their income rather than capital.
This loss relief massively de-risks their investment. An investor can get 30% of tax credit upfront to invest. If they make a massive gain they don’t have to pay tax on it, and if they make a loss they can offset it against their income, which means investors get a good deal in every outcome.
Seed enterprise investment scheme (SEIS)
The seed enterprise investment scheme is a similar offering but for smaller companies. Investors stand to get 50% income tax credit rather than 30% as is the case with the EIS. When an investor sells their shares in a company, that transaction will also be capital gains tax free, if the shares are sold after three years.
To qualify for this investment scheme, your company has to be relatively new, so it can’t have traded for more than two years when you register for the scheme, and it has to be permanently established in the UK. Further to that, your business can’t have more than 25 employees, or raise more than £100,000 in total under SEIS.
If a tech business is looking to raise funds, it’s really important for them to consider registering for EIS and SEIS because it will make people feel a lot more relaxed about investing.
Research and development tax relief (R&D)
Research and development tax relief is for businesses that are working towards solving a problem in their market where a more efficient or new solution is needed. To qualify, there has to be uncertainty over whether the company is going to be paid after they put the time and money into innovation, and it has to advance knowledge in the field, not just for the business.
R&D tax credit, or innovation funding as it’s sometimes called, is more of a small company scheme incentive, with relief set at 230%.
For businesses that successfully apply, they get a reduction in tax on their business profits or a cash payment from HMRC if the company doesn’t make profits.
So, if you’re a young tech company and you’ve never made any profits or paid any corporation tax, you can actually surrender your R&D tax credit and get a refund in cash.
You’ll normally receive your tax credit within four weeks of submitting a claim. However, if you surrender the tax credit you won’t get the full 230%, instead it’ll be a bit less. This is usually around 10 or 11% of what you spend.
Normally what companies will do is take the 230% tax credit or carry it forward. Yet many early stage tech companies may prefer to have that money now rather than wait until further down the line.
And there are also a few criteria which limit the R&D relief you can claim. You can only claim on:
- money that’s been spent, not money that you expect to spend at a certain time in the future
- expenditure and not fixed assets, which means you can’t get relief on any purchases that add long-term value to the business
- money that hasn’t been funded from elsewhere, such as a grant, because you’ll have already received relief on it
- the salary you were actually paid, rather than what your salary is stated to be – you may give yourself a large salary but end up sacrificing it because your company can’t afford it.
Any claim for R&D relief has to be made within two years of the end of the accounting period. Otherwise it’s out of date.
You can claim entrepreneurs’ relief for the first £10 million of gains on your shares in your company if:
- you’re the director of your company
- you own 5% or more of the shares
- you’ve held those shares for more than one year.
This money is taxed at 10% rather than 28%, which is what the capital gains tax rate would be.
There are, however, some factors that could affect your chances of obtaining entrepreneurs’ relief. Holding cash within the company that isn’t part of its revenue, for instance. These include investment assets that aren’t trading assets or money that you don’t take out as income, which would normally be taxed at 40%.
Put simply when it comes to selling part of your company HMRC won’t allow you to sell cash for cash and get 10% tax relief on it. For more information on Chris Cairns, visit Alliotts.
If you’re interested in finding out how to recognise different IT and tech products and services on your tax returns, take a look at our next instalment, Part two: How to recognise revenue on software and other products and services.
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