EIS: income tax relief: general requirements: no disqualifying arrangements requirement
The ‘no disqualifying arrangements’ requirements was introduced in respect of shares issued on or after 6 April 2012.
This test is intended to prevent the schemes being used primarily for the purpose of delivering a tax mitigation product to investors with little or no other commercial purpose; or of delivering the benefits of tax-advantaged finance to another entity or project which would not itself qualify for support under the schemes or whose owners do not want to relinquish equity. The intention is to disqualify companies which would be unlikely to exist in the first place, or would be unlikely to carry on the particular activities in question (or to carry them on in the manner proposed), were it not for the desire to achieve one or both of those particular aims.
The legislation consists of several subsections.
Subsection (1) operates by preventing an issue of shares by an EIS or SEIS company, or shares or securities by a VCT investee company, from qualifying under the schemes if those shares or securities are issued, or any money raised by the issue, is employed (‘spent’ in the case of SEIS) in consequence of or in anticipation of, disqualifying arrangements.
To determine whether arrangements are ‘disqualifying’ or not, subsection (2) examines the purpose of the ‘arrangements’ in question. If the main purpose, or one of the main purposes, is both to secure that:
- A qualifying business activity is or will be carried on by the company or by a qualifying 90% subsidiary (that activity being the one for which the relevant shares are issued to raise money) and
- that relevant tax relief is available or the company will form part of a VCT’s qualifying holdings,
then we are required to consider whether one or both of Condition A and Condition B are met; if either is met then the arrangements are ‘disqualifying’.
What subsection (2) requires us to consider is whether the purpose of the arrangements is to create an activity or the appearance of an activity which will qualify under the schemes so that the tax advantages will be available.
Examples might include (without necessarily being limited to):
- cases where a business appears to be fragmented in a way which is commercially unusual with the result that there is a company which (apart from this test) meets the qualifying conditions for the schemes;
- cases where a transaction which would normally be expected to be between two parties, involves three (or more) parties, where the additional party is a company which (apart from this test) meets the qualifying conditions for the schemes
- cases where the economic substance of a company’s activity appears to be at odds with its form (for instance, where contractual arrangements appear designed to generate an outcome similar to a lending or credit facility whilst the contracts are not immediately obviously loan or credit contracts in legal form).
The remainder of the legislation needs to be considered only where arrangements have such a purpose. Where that’s the case, if either Condition A or Condition B is met, the arrangements are ‘disqualifying’.
Condition A at subsection (3) is that as a result of the money raised by the relevant issue being employed for the purpose of the relevant business activity, the whole or the majority of the amount raised is, in the course of the arrangements, paid to or for the benefit of a party or parties to the arrangements or a person or persons connected with such a party.
Condition B at subsection (4) is that, in the absence of the arrangements, it would have been reasonable to expect that the whole or greater part of the component activities of the relevant business activity would have been carried on as part of another business by a person or by persons who are party to the arrangements or a person or persons connected with such a party.
‘Arrangements’ for the purposes of this legislation is defined as including ‘any scheme, agreement, understanding, transaction or series of transactions (whether or not legally enforceable)’. It is immaterial whether the company itself is party to all parts of the arrangements in question, and it is immaterial whether a person who is a party to part of the arrangements is aware of the purpose of the arrangements as a whole.
‘Relevant tax relief’ means SEIS or EIS income tax relief; share loss relief as provided for by Chapter 6 of Part 4 of ITA 2007; capital gains disposal relief as provided by sections 150A or 150E of TCGA 1992; EIS capital gains deferral relief; or SEIS capital gains reinvestment relief.
See VCM14030+ for information about this legislation in the context of the HMRC’s advance assurance facility.