A form of Irish income tax relief for investment in private Irish companies has been available since the 1980s. The latest guise is known as EIIS or sometimes EII (the terms are used interchangeably by authorities and advisers alike). There was an overhaul to the regime in 2018 with some minor modifications in recent Finance Acts.
The relief is regarded as a form of State Aid and is designed to encourage equity investment in the SME sector - with the purpose of supporting the creation and retention of Irish employment.
Individual investors
From the investor’s perspective, EIIS is relatively straightforward. Irish tax relief is available against income tax only, resulting in maximum relief at the 40 percent rate – there is no relief available against USC or PRSI. EIIS investments by can be made directly in a company or through a fund which invests in a variety of companies; funds can provide more balance and diversification. Previously relief was available on a phased basis, adding complication, but this is no longer the case. In addition, the fundraising company now “self certifies” which means that there is no longer any requirement for Irish Revenue clearance – something which caused delays in the past. In practice, these changes mean investors can claim their tax relief almost immediately after their investment.
For investors, there are other crucial points to note:
The rules provide a mechanism for clawback of relief where various conditions are not satisfied. However, this clawback will usually be a liability of the company – and not the investor.
The investor must retain the shares for four years. Failure to do so will result in one of the occasions where the investor personally suffers a clawback of the relief.
The investor can not be ”connected” to the company, for example a relative of the controlling shareholder. There are some limited exceptions here, including where relief is available under the Start up Capital Investment (SCI) regime, a variant of EIIS.
Loss relief is restricted for EIIS shares. Typically, a capital loss on shares investment can offset other capital gains. The restriction of losses for EIIS shares limits their attractiveness for investors. These shares carry risk by their very nature and the possibility of a loss should always be considered on each investment decision.
The fundraising company
Broadly, a company would be eligible for EIIS finance where it is regarded as “Qualifying Company” and the investment is a “Qualifying Investment”. Further commentary is provided on these terms below.
It should be noted that even where a company satisfies these requirements, then other provisions may impact entitlement or result in relief no longer being available. For example, there are rules which need to be navigated on EIIS investor exit or on any other investor receiving value from the company (in a timeframe commencing two years prior to the investment). When the company is initially considering an EIIS raise, the exit plan should always be considered - at the very least to ascertain whether the proposed plans are compatible with EIIS requirements.
In advance of any fundraise, a comprehensive review of all conditions would need to be undertaken. Failure to satisfy any of the conditions will result in the company suffering the clawback of tax relief claimed, along with an interest exposure. The potential exposure here can often limit a company’s appetite for EIIS financing, especially given the complexity of the regime.
“Qualifying company”
The fundraising company’s “RICT Group” would need to be ascertained at the outset. To be a “qualifying company” certain conditions need to be satisfied by each member of the RICT Group. An RICT Group is defined by reference to EU law and includes the fundraising company and all its partner and linked businesses; these can include sole trades or partnerships. Determining an RICT Group can be a complex and onerous exercise. It can require consideration of the other business interests held by individual shareholders and examining these to determine whether they are in the same or adjacent market.
Broadly, the key conditions which need to be satisfied at date of investment are:
The company exists wholly for carrying on “relevant trading activities”. This definition is relatively broad and includes most trades apart from those on an “excluded” list. Some of those excluded are financing activities, professional services and certain hotel operators. Professional services are specifically defined; incorporating legal, accounting and medical type services amongst others. The definition does not include engineering or computer programming activities. Thus ‘high tech’ startups should usually satisfy this test.
The RICT Group must:
o Be an SME (less than 250 employees and has an annual turnover not exceeding €50 million or an annual balance sheet total not exceeding €43 million),
o Be unlisted, with no arrangements to become listed and
o Not be subject to an outstanding recovery order, following a previous decision of the Commission in respect of State Aid.
The RICT Group should not be an “Undertaking in Difficulty” i.e. at significant risk of going out of business in the medium to short term without State intervention. A limited company will be an “Undertaking in Difficulty” where it has seen more than half of its subscribed share capital and share premium disappear as a result of accumulated losses. Helpfully, the Undertaking in Difficulty test does not apply to a RICT Group that is less than 3 years in existence. Often such ventures have significant startup costs and would not otherwise meet this condition.
The company should have a general Tax Clearance certificate.
There are further conditions which will need to be met throughout the entire period of four years from investment date. One of which is that, during this period, the company should not be under the control of another company. This limits flexibility for founder(controlling) shareholders, as they often prefer to own their interest via a holding company.
Qualifying Investment
In order to be a “qualifying investment” the shares must be eligible shares and various other conditions must be met. “Eligible shares” can be redeemable and carry preferential rights to dividends or preferential rights on winding up.
There can be no terms which will reduce the risk of the investor. Furthermore, there can be no agreements made with the investor, which substantially reduce the risk that the investor will receive their capital back or any expected dividend.
Other conditions
The company must use the funds for a “qualifying purpose”; this includes using the investment for the purpose of “relevant trading activities” (see above) where the use of the money will contribute directly to the creation or maintenance of employment in the company.
The Fund Investment needs to be based on a Business Plan. This should contain details of product, sales and profitability development establishing ex-ante financial viability. It should include both quantitative and qualitative details of the activities the investment is sought to support.
In order to be qualifying investment, conditions need to be met in respect of the type of finance category raised. The investment must either fall into the categorisation of initial risk finance, expansion risk finance or follow-on risk finance. For follow-on risk finance to be a qualifying investment, the possibility of raising that follow-on investment must have been foreseen in the original Business Plan. For the other categories, then broadly the RICT Group must fulfil one of the following:
o They have not been operating in any market (initial risk finance);
o They have been operating in any market for less than 7 years following their first commercial sale (initial risk finance);
o They require a finance investment which, based on a business plan prepared in view of entering a new product or geographical market, is higher than 50 percent of their average annual turnover in the preceding 5 years (expansion risk finance).
In the above context, the RICT Group will include any enterprise which was at any time a member of the group.
There is a limit on overall investment that can qualify for relief into an RICT group (to include companies that were at any time members of the RICT group). The limits are a lifetime amount of €15,000,000 or a €5,000,000 limit in any rolling 12-month period.
Administrative requirements
Along with the requirements surrounding qualifying company and qualifying investment, there are other administrative requirements that need to be met including submission of a specific tax return (RICT return) and provision of a Statement of Qualification (SOQ) to the investor. The SOQ should be automatically generated once the RICT return is submitted.
In addition, certain employment growth or R&D metrics must be met by the third-year of the investment.
EU rules – update
As noted above, EIIS is regarded as a form of State Aid and needs to satisfy EU rules. We thus need to be mindful of any changes which may impact the Irish regime in future.
In March 2023, the European Commission announced an update to GBER, which is the current framework for the Irish EIIS rules. The press release notes that the changes clarify and streamline the possibilities for risk finance aid (such as EIIS). It is envisaged that the measures will be formally adopted in the coming weeks.
The update includes a significant change which will limit the tax relief available to an investor. The proposals limit to 35 percent the tax relief available to an investor for “initial” risk finance; which includes investment obtained within 7 years of first commercial sale or 10 years of registration. More significantly from an Irish perspective, the tax relief limit reduces to 20 percent for investments regarded as expansion risk finance (as defined). While there is a provision for a maximum limit of 50 percent tax relief for initial risk finance in cases where the group was not operating in any market, this can be a difficult to satisfy as investors often require a ‘business case’ proof of concept.
The Irish EIIS rules currently allow a maximum of 40 percent tax relief irrespective of the nature of the investment. The Commission notes that where a State Aid measure (such as EIIS) does not meet the criteria of the GBER, this does not mean that it is incompatible with EU state aid rules. It only means that the measure must be notified (prior to its implementation) to the Commission, which will then assess whether the State aid can be approved under other EU State aid rules.
There has been no commentary yet from the Irish Government as to what its approach will be here; in particular whether the current regime could be retained via separate EU State Aid application.
Absent this course by Government, it appears that changes to the Irish domestic EIIS regime are inevitable – which is likely to impact future fundraising by SMEs.
Article published in June 2023 edition of Tax.Point - the tax journal for Irish Chartered Accountants
