27 January 2010
In the recent case of Skye Inns Limited & Mr Chris O. Richards v Commissioners for Her Majesty's Revenue and Customs the taxpayer lost the appeal for claiming EIS relief, failing on the 80% of monies "employed in business" test.
The judgement is useful in confirming that monies can be "employed" without being spent. But it also confirms that one must trace the use of the actual monies raised under EIS. It is not sufficient that the company has spent other monies of an equal amount.
The appeal depended on whether the Appellants could demonstrate that Skye Inns Limited ("Skye") had "employed" 80% of the cash contributed to it, when Mr Chris Richards ("Mr Richards") subscribed £1,536,684 of shares in the company, in Skye's qualifying trade within the 12 months of the subscription. At the time of the subscription Skye owned 2 restaurants, both of which were making significant losses.
This legislation was relaxed in the Finance Act 2009 such that the subscription monies now have to be employed in the company's business within 2 years of the subscription rather than within 12 months, but this case is a good example of how the tribunals will interpret this test.
The facts of the case were unfortunate in that, following Mr Richards' subscription at the end of 2001, the intention had been that Skye would purchase a pub/restaurant (the Old School House). It was hoped that this acquisition would fund the losses of the other two restaurants that Skye operated. Unfortunately the purchase fell through. Had it been completed, the combination of the purchase price of £820,000, funding the losses of the other 2 restaurants and numerous repairs and improvements to the 3 restaurants would have ensured that 80% of the monies subscribed in December 2001 would have been employed within Skye's business.
By November 2003, Skye was still unable to locate a suitable alternative acquisition and instead it was considered by the directors that it was now more appropriate to undertake major improvements to the 2 existing properties rather than continue the search for a third property.
For the year ended 2003 the company's accounts showed that Skye still had £1,229,071 on deposit with its bankers, and it was HMRC's view that these monies were not "employed in the trade".
The tribunal considered 3 main issues:
The purchase of a third outlet
It was contended that Skye had been about to make a major acquisition which would have ensured compliance with the requirements of the EIS legislation and when the purchase fell through the directors had continued their search and had never applied the cash in any form of non-qualifying investment. The tribunal considered that if a contract was due to be completed within a 12 month period but, due to the breach of the other party, was completed shortly after the expiry of the 12 month period, then it could be said that the cash ear-marked for the acquisition was "employed in the business". In this case however, the argument was weaker as there was no contract and Skye merely envisaged that the cash would be "employed in the business", but it was not bound to do so.
The invidious choice faced by the directors
The tribunal sympathised with the directors of Skye as they were faced with the unenviable choice of making an acquisition in order to satisfy the tax tests, even though they were not content that the acquisition was a prudent one. Despite this, the tribunal reiterated that the tax test imposed a definite time period (now 24 months rather than 12) and there was no exception for the situation where directors wanted to meet the test but were unable to do so.
Working capital requirements
The tribunal stated that the subscription monies did not actually have to have been spent to satisfy the "employed in the business" test. Instead, the test could be satisfied if there was a genuine requirement that the company's funds (subscription cash and trading receipts) were all required to be kept as working capital in order to meet business requirements, including to turn the business round from loss to profit.
In this case however, Skye had attempted to argue that the gross cost of the business was met out of the subscription monies alone with the gross income remaining unspent. The tribunal concluded that the only realistic approach was to treat funds raised in the share issue as having been employed in the business only when they are actually used on increasing the company's net trading assets or when reserved to supplement the current trading receipts. It could be argued that the subscription monies were ring-fenced and employed in the business in priority to other income.
The EIS tests remain strict and whilst the 12 month period has recently been increased to 2 years, the 80% test must still be satisfied. The tribunal will look at each case on its facts, and this case highlights some of the issues that the tribunal will consider when applying the 80% test.