State Sponsored Funding for your Company

A common complaint of small to medium enterprises in Ireland is the lack of sufficient funding from the banks to adequately cater for the sustainability, growth and expansion of the business but are we barking up the wrong tree.

It is evident from the post Celtic Tiger Trauma that our enterprises were over reliant on bank funding for both working and investment capital and that this reliance posed a serious risk to financial stability rather than supporting it. It is for this reason that the SFA, IBEC and the Central Bank among others have been to the fore in encouraging the SME sector to seek non-bank finance where appropriate.

One of the more attractive non bank sources of funding is the under utilised Employment Incentive Investment Scheme (“EIIS”). Under this scheme, the company is guaranteed and minimum investment period of 4 years and the Irish taxpayer investor is guaranteed tax relief on the funds invested, which could equate to a 40% tax free dividend on the investment. The benefit to the Government in granting tax relief is to encourage equity investment as opposed to bank debt, to gain an uplift in employment and or R&D activity.

A soft landing?

Many of our early stage companies in particular rely on family and friends for funds, mostly with no security provided. The EIIS provides a measure of security for investors who satisfy certain conditions in offering a potential 40% refund for the amounts invested. Provided the investor has sufficient taxable income to shelter and the company meets certain conditions relating to increased employment or R&D, an investment of €10,000 could amount to a net investment of €6,000.

The solace in knowing that at least a portion of the investment may be returned is an important incentive for the investor and should also imbue the investee company with a confidence in approaching investors in the knowledge that even if the company ultimately fails that their EIIS investors will at least gain some recompense for their entrepreneurial spirit.

It is hoped that this article will raise more awareness of the EII scheme, encourage companies to seek investment in this manner and encourage more individuals to invest in the share equity of companies they believe in.

The scheme

The legislation is quite complex containing many restrictions and conditions which when satisfied entitle:

  • individuals in general to claim tax relief) under EIIS
  • “specified individuals” to claim seed capital relief  under the Startup Refunds for Entrepreneurs (SURE) scheme

The intention of SURE is to encourage employees to set up their own businesses with rebates of tax paid under PAYE in previous years to help capitalise the new business.

The relief is available in respect of money subscribed for ordinary shares in:

  • an unquoted trading company incorporated within the EEA, and carrying on business through a branch or agency in the State; or
  • a company resident in the State.

The investment

An EIIS investment may be made in a new company or in an existing company which was established no more than seven years prior to investment.

A company may raise up to €5m annually subject to a lifetime limit of €15m.
An Irish tax resident individual may invest from as little as €250 to a maximum of €150,000 in eligible shares in a qualifying company in any tax year. The relief is a generous relief in that it can be used to shelter the total income of the investor not just PAYE or trading income. It could be particularly useful therefore for those investors in receipt of passive income such as rental income.
It is ‘money invested’ that qualifies so shares for assets or shares for loan forgiveness will not qualify for EII relief.
There is an exception in relation to SURE in that a seed capital investor may convert a director’s loan to share capital if the investor has met company expenses from his/her own resources and this is considered a directors loan and the conversion happens within 12 months. The loan must be cash injected and not a notional salary foregone.

Relief granted in two tranches

Relief under the EII is claimed in two tranches, so should a taxpayers marginal rate be 40 per cent, 30 per cent is claimed in Year 1 and assuming the company meets certain employment criteria or has increased research and development expenditure in a 3 year comparative period, 10 per cent is claimed in Year 4.

Commercial risk

Like any investment there has to be normal commercial risk for the investors in the scheme and there can be no arrangement which would protect the EII investors against a loss after the end of the specified period.

Use of EIIS funds

It is required that the money invested by the individual for eligible shares in the qualifying company either was used, is being used or is intended to be used:

a)    for the purpose of carrying on relevant trading activities ; and
b)    where the company has not commenced to trade, in incurring expenditure on qualifying research and development.

In addition, the legislation requires that the money is used with a view to the creation or maintenance of employment in the company.

Value received

Investors are denied the full benefit of the relief if they receive value from the company. As an investor you would be treated as receiving value from the company where the company:

  • makes a payment to you for giving up the right to payment of a debt (other than an ordinary trade debt)
  • repays a debt owed to you that was incurred before you subscribed for the shares
  • provides you with certain benefits or facilities other than benefits subject to PAYE as a company employee
  • waives any liability of yours or an associate's to the company
  • undertakes to discharge, any such liability to third parties, and
  • lends you money which has not been repaid before the shares are issued

Summary

The SME sector has an advantageous alternative to the trials, tribulations and costs of seeking finance through the more traditional routes. With proper advice, the under utilised EIIS and SURE reliefs both offer the SME sector an opportunity to move away from it’s over reliance on bank finance and to release the costs associated with such finance to fund the trading activity of the company.

Pat O’Shea, Tax, Mazars, Phone + 353 (0)1 449 44 00 Email: poshea@mazars.ie