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HMRC internal manual

Venture Capital Schemes Manual

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HM Revenue & Customs
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EIS: income tax relief: the issuing company: financial health requirement

ITA07/S180B

This legislation applies in respect of shares issued on or after 6 April 2011. It was introduced as part of the conditions under which the schemes were granted State Aid approval by the European Commission.

The requirement is that the issuing company must meet the financial health requirement at the beginning of Period B - that is, at the date the shares are issued. (See VCM10540 for an explanation of Period B.)

At the relevant time, the company must not be ‘in difficulty’. The company is ‘in difficulty’ if it is reasonable to assume that it would be regarded as ‘a firm in difficulty’ for the purposes of the European Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty (2004/C244/02).

The EC Guidelines in question are lengthy, but the following paragraphs are most relevant for the purposes of the EIS rules:

‘9. There is no Community definition of what constitutes ‘a firm in difficulty’. However, for the purposes of these Guidelines, the Commission regards a firm as being in difficulty where it is unable, whether through its own resources or with the funds it is able to obtain from its owner/shareholders or creditors, to stem losses which, without outside intervention by the public authorities, will almost certainly condemn it to going out of business in the short or medium term.

  1. In particular, a firm is, in principle and irrespective of its size, regarded as being in difficulty for the purposes of these Guidelines in the following circumstances:
in the case of a limited liability company, where more than half of its registered capital has disappeared and more than one quarter of that capital has been lost over the preceding 12 months;

in the case of a company where at least some members have unlimited liability for the debt of the company, where more than half of its capital as shown in the company accounts has disappeared and more than one quarter of that capital has been lost over the preceding 12 months;

whatever the type of company concerned, where it fulfils the criteria under its domestic law for being the subject of collective insolvency proceedings.
  1. Even when none of the circumstances set out in point 10 are present, a firm may still be considered to be in difficulties, in particular where the usual signs of a firm being in difficulty are present, such as increasing losses, diminishing turnover, growing stock inventories, excess capacity, declining cash flow, mounting debt, rising interest charges and falling or nil net asset value. In acute cases the firm may already have become insolvent or may be the subject of collective insolvency proceedings brought under domestic law. In the latter case, these Guidelines apply to any aid granted in the context of such proceedings which leads to the firm’s continuing in business. In any event, a firm in difficulty is eligible only where, demonstrably, it cannot recover through its own resources or with the funds it obtains from its owners/ shareholders or from market sources.

  2. For the purposes of these Guidelines, a newly created firm is not eligible for rescue or restructuring aid even if its initial financial position is insecure. This is the case, for instance, where a new firm emerges from the liquidation of a previous firm or merely takes over such firm’s assets. A firm will in principle be considered as newly created for the first three years following the start of operations in the relevant field of activity.’

Whether it is ‘reasonable’ to assume a company is ‘in difficulty’ in this context might be open to interpretation. HMRC intend to follow the example of the Guidelines and will not regard a company as falling within the scope of the restriction if at the date of issue of the relevant shares:

  • it is within the first three years of operations in the relevant field of activity and/or
  • it has been able to raise funds from its existing shareholders or from the market sufficient to meet its anticipated funding requirements at that time.