The Enterprise Investment Scheme ("EIS") is a government-approved scheme designed to encourage investment in start-up and early stage UK companies. It offers tax reliefs for the investor, including income tax relief on the amount invested and capital gains tax ("CGT") exemption on a future sale of the shares (subject to certain criteria).
Background to the case
In 2005 Mr Ames, a qualified skydiving instructor, invested £50,000 for shares in a start-up indoor skydiving company where he was also one of the founder directors. HMRC confirmed that the shares were eligible for income tax relief under EIS.
Mr Ames sold his shares in 2011 for over £300,000. Before he sold his shares, he had been advised by HMRC in a recorded phone call that his profit would be exempt from CGT. Despite this, when claiming CGT relief under EIS in his self-assessment tax return, HMRC refused on the basis that as he had not obtained income tax relief when he first acquired his shares, he was not eligible for CGT relief. Mr Ames had not claimed income tax relief because, in the tax year in which he acquired his shares, he earned just £42 of employment income, which was fully covered by his personal allowance. He therefore had no tax liability against which he could claim income tax relief.
Mr Ames believed that the two reliefs (income tax and CGT) were separate and not interdependent. He argued that linking the two reliefs means an investor with, say, just ten pounds of income above the personal allowance, can claim income tax relief and then get a full CGT exemption, but an investor with no income gets no CGT exemption at all. HMRC refused to accept his argument and claimed Mr Ames owed over £70,000 in CGT.
Mr Ames later tried to make a late claim for EIS income tax relief on the basis of having a "reasonable excuse" for the delay but HMRC refused to accept his late claim.
Having lost at the First-tier Tribunal, Mr Ames appealed to the Upper Tribunal, arguing that the right to EIS CGT relief is not dependent on obtaining EIS income tax relief. He also brought a judicial review against HMRC’s decision not to allow his late claim for income tax relief.
Although Mr Ames was unsuccessful on appeal in delinking the two reliefs, the Upper Tribunal "quashed" the original HMRC decision to disallow the late claim for income tax relief and has ordered HMRC to make the decision again, this time taking all relevant factors into account. If Mr Ames's claim is allowed Mr Ames can then claim CGT relief on the sale of his shares.
Why it matters
Following the Upper Tribunal decision, HMRC’s interpretation of the law stands – i.e. there is a linkage between income tax relief and CGT relief. This could affect many other risk-taking entrepreneurs with little or no income who plough all their savings into a new business. As they have no income tax liability, they cannot claim income tax relief on their investment and therefore they will never be eligible for CGT relief on a future sale. This effectively turns the EIS into a tax relief only for the rich and for high earners, which is unlikely to have been what Parliament intended.