EIS Compliance: Meeting the two-year qualifying trade requirement – lessons from Putney Power
The Enterprise Investment Scheme (“EIS”) incentivises investment in high-risk, early-stage companies by offering a range of tax reliefs to investors. To qualify for EIS, companies must satisfy certain criteria, with one of the most important being the requirement to carry out a “qualifying trade” within two years of receiving investment.
This article explores the concept of a qualifying trade, the implications of failing to meet the two-year deadline and key insights from the Putney Power Ltd case. Additionally, we provide practical advice on ensuring compliance and securing your EIS status.
What is a qualifying trade under EIS?
Most trades are considered qualifying trades under EIS; however, certain trades are deemed to be excluded activities by HMRC. These include:
- leasing activities;
- legal or financial services;
- property development; and
- banking, insurance, debt or financing services.
Excluded activities typically involve lower-risk or passive income streams, which fall outside the scheme’s objective of promoting innovation and growth of companies in high-risk sectors. Please see here for a full list of excluded activities.
If your company carries out both qualifying and excluded activities, EIS eligibility will depend on the proportion of revenue and resources allocated to each. To qualify:
- No more than 20% of total activities (by turnover, time, or assets) can come from excluded activities.
- The primary purpose of the company must be a qualifying trade.
If your company has mixed activities, seeking advance assurance from HMRC can help clarify your EIS eligibility.
Understanding the two-year qualifying trade requirement
To qualify for EIS, the investment must be directed towards promoting the growth and development of a qualifying business activity. This means that your company must:
- be carrying out a qualifying trade;
- be preparing to carry out a qualifying trade; or
- be engaged in research and development that is expected to lead to a qualifying trade.
If your company is seeking to carry out an excluded activity, it will not qualify for EIS.
However, if your company aims to carry out a qualifying trade, it will only qualify for EIS if you commence a qualifying trade within two years of receiving the investment. This two-year requirement helps ensure that your EIS-qualifying company is actively growing and developing its qualifying business activity.
Case Study: Lessons from Putney Power Ltd
The Putney Power Ltd case (October 2024) highlights the importance of meeting the two-year qualifying trade requirement.
The scenario:
Putney Power Ltd raised funds under EIS to construct power stations for generating and selling electricity. However, the company failed to supply electricity to clients within two years of receiving the investment. As a result, HMRC revoked the company’s EIS-qualifying status, withdrawing the tax reliefs granted to its investors.
The tribunal’s decision:
The tribunal determined that a company is only considered to have commenced a trade when it is “open for business.” In this case, Putney Power Ltd was still in the preparation phase and had not begun providing goods or services to the market.
The tribunal used the analogy of a restaurant to explain this distinction:
- A company that has signed a lease, fitted out the premises and purchased equipment is merely preparing to carry out a qualifying trade.
- The company only becomes “open for business” when it starts serving customers.
Key takeaway:
Operational readiness alone is insufficient to meet the two-year deadline. Your company must actively provide goods or services to the market and must be fully operational and generating revenue (or at least making genuine attempts to do so) within this timeframe to maintain its EIS-qualifying status.
Consequences of not meeting the two-year qualifying trade requirement
Failing to meet the two-year qualifying trade requirement can have serious consequences:
- Loss of EIS Status: Your company’s EIS-qualifying status will be revoked.
- Investor Tax Relief Withdrawal: Investors may lose the tax reliefs associated with their EIS investment.
- Reduced Investor Confidence: Losing EIS status can deter future investment, as investors may perceive your company as higher risk.
Practical Tips for Ensuring Compliance
- Plan Ahead: Develop a clear timeline for commencing your qualifying trade and ensure that your business is operational within two years of receiving investment.
- Document Progress: Keep detailed records of activities leading up to the commencement of trade to demonstrate compliance if challenged by HMRC.
- Engage Professionals: Seek advice from EIS specialists to navigate the complexities of the scheme and ensure you meet all requirements.
FAQ’s
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Can I apply for EIS if my company is still in the development phase?
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Yes, if your company is engaged in research and development (“R&D”) that is expected to lead to a qualifying trade, it can still qualify for EIS. However, you must demonstrate that the R&D will result in an active trade within a reasonable timeframe.
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What happens if my company doesn’t start trading within two years?
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If your company fails to commence a qualifying trade within two years of receiving EIS investment, HMRC can revoke your EIS status. This means:
- Investors lose their income tax relief (usually 30% of their investment).
- Any capital gains tax exemptions related to the investment may be withdrawn.
- Investors may need to repay tax reliefs they have already claimed.
This can make it harder to attract future investment, as investors may see your company as a higher-risk opportunity.
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How does HMRC determine whether a company is “open for business”?
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HMRC considers a company to be “open for business” when it has started providing goods or services to customers. HMRC may request evidence such as:
- Sales invoices or contracts with customers
- Proof of transactions (e.g., bank statements showing revenue)
- Marketing or advertising materials demonstrating an active business presence
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Can I get an extension if I’m close to the two-year deadline but haven’t started trading?
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No, HMRC does not grant extensions for the two-year rule. If your company is nearing the deadline and has not yet started trading, you should take immediate action to ensure that you meet the requirement. If you are still in the R&D phase, you may need to provide evidence that your activities will lead to a qualifying trade.
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Can I apply for EIS advance assurance before I start trading?
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Yes, you can apply for EIS advance assurance before you start trading. This process allows you to confirm with HMRC that your company qualifies for EIS before seeking investment. However, you must demonstrate that you intend to commence a qualifying trade within two years. Advance assurance does not guarantee EIS status but provides investors with greater confidence.
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How can I prove to HMRC that my company has commenced trading?
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To demonstrate that your company has started trading, you should keep records such as:
- Sales invoices and contracts showing transactions with customers
- Bank statements reflecting revenue from business activities
- Employment records indicating active staff involved in trading operations
- Marketing materials and website activity demonstrating an active business presence
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What should I do if HMRC challenges my EIS status?
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If HMRC questions whether your company has met the two-year qualifying trade requirement, you should:
- Gather evidence of trading activity, such as invoices, contracts, and financial records.
- Consult an EIS specialist to review your case and provide professional guidance.
- Engage with HMRC proactively, responding to any requests for additional information. If necessary, you can appeal an HMRC decision through the First-tier Tax Tribunal, as seen in the Putney Power Ltd case.
-
Can I apply for EIS if my company is still in the development phase?
-
Yes, if your company is engaged in research and development (“R&D”) that is expected to lead to a qualifying trade, it can still qualify for EIS. However, you must demonstrate that the R&D will result in an active trade within a reasonable timeframe.
-
What happens if my company doesn’t start trading within two years?
-
If your company fails to commence a qualifying trade within two years of receiving EIS investment, HMRC can revoke your EIS status. This means:
- Investors lose their income tax relief (usually 30% of their investment).
- Any capital gains tax exemptions related to the investment may be withdrawn.
- Investors may need to repay tax reliefs they have already claimed.
This can make it harder to attract future investment, as investors may see your company as a higher-risk opportunity.
-
How does HMRC determine whether a company is “open for business”?
-
HMRC considers a company to be “open for business” when it has started providing goods or services to customers. HMRC may request evidence such as:
- Sales invoices or contracts with customers
- Proof of transactions (e.g., bank statements showing revenue)
- Marketing or advertising materials demonstrating an active business presence
-
Can I get an extension if I’m close to the two-year deadline but haven’t started trading?
-
No, HMRC does not grant extensions for the two-year rule. If your company is nearing the deadline and has not yet started trading, you should take immediate action to ensure that you meet the requirement. If you are still in the R&D phase, you may need to provide evidence that your activities will lead to a qualifying trade.
-
Can I apply for EIS advance assurance before I start trading?
-
Yes, you can apply for EIS advance assurance before you start trading. This process allows you to confirm with HMRC that your company qualifies for EIS before seeking investment. However, you must demonstrate that you intend to commence a qualifying trade within two years. Advance assurance does not guarantee EIS status but provides investors with greater confidence.
-
How can I prove to HMRC that my company has commenced trading?
-
To demonstrate that your company has started trading, you should keep records such as:
- Sales invoices and contracts showing transactions with customers
- Bank statements reflecting revenue from business activities
- Employment records indicating active staff involved in trading operations
- Marketing materials and website activity demonstrating an active business presence
-
What should I do if HMRC challenges my EIS status?
-
If HMRC questions whether your company has met the two-year qualifying trade requirement, you should:
- Gather evidence of trading activity, such as invoices, contracts, and financial records.
- Consult an EIS specialist to review your case and provide professional guidance.
- Engage with HMRC proactively, responding to any requests for additional information. If necessary, you can appeal an HMRC decision through the First-tier Tax Tribunal, as seen in the Putney Power Ltd case.
How we can help
Ensuring compliance with the two-year qualifying trade requirement is essential to maintaining your company’s EIS-qualifying status and protecting your investors’ tax reliefs. The Putney Power Ltd case underscores the importance of taking timely action and being fully “open for business” within the required timeframe.
If you have concerns around whether you qualify for EIS or are interested in submitting an EIS advance assurance or compliance statement application, we offer a no-cost, no-obligation 20-minute introductory call as a starting point and in some cases, where appropriate, a fixed fee appointment.
Please email wewillhelp@jonathanlea.net providing us with any relevant information ensuring that any call we have is as productive as possible or call us on 01444 708640. After this call, we can then email you a scope of work, fee estimate (or fixed fee quote if possible), and confirmation of any other points or information mentioned on the call.
This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.
