When considering whether EIS funding might be an option for your company, one of the first questions to ask is whether your company is carrying on any ‘excluded activities’.
In most cases this means a quick Google search and ticking off the checklist. There are a considerable number of activities which are excluded, such as property development, shipbuilding and energy generating activities (a full list can be found here).
One important point to remember is that, despite the name, excluded activities don’t necessarily exclude you from EIS. Instead, you have to consider whether excluded activities amount to ‘a substantial part’ of your trade. As the meaning of ‘substantial’ is not provided anywhere in the EIS legislation, HMRC considers such cases individually.
The rule of thumb to keep in mind is that as long as the excluded activity accounts for less than 20% of the whole trade, then usually such activities will not be ‘substantial’. When HMRC is considering the activities of a company as a whole, they may look at such aspects as turnover, assets used in the business, or the time spent by management/employees on different activities, although again this will very much depend on the particular situation of a company.
Many companies seeking EIS funding will likely not be carrying on or planning to carry on any excluded activities, with the notable exception of receipt of royalty and licence fees. If a company is creating IP or developing a service which it plans to licence to its customers, the receipt of licence fees or royalties may naturally be a large part of their (future) business.
There is an important waiver to this general exclusion, which applies where a company has created the whole or the greater part of the value of the “Relevant Intangible Asset” (“RIA”) from which licence or royalty fees are derived. This allows companies to acquire IP at an early stage, for example, and develop it significantly to where they have created the greater part of it in terms of cost (even if it’s only £1 more!), and the receipt of any licence or royalty fees stemming from this would not be considered as an excluded activity. The exclusion would automatically apply where a company has developed all of the IP themselves.
It’s important to note that such an RIA does not have to exist on the company’s balance sheet; there need only be the possibility that you could put the asset on your balance sheet in line with IFRS. As a result, companies would not need to worry about capitalising this intangible asset (unless they wish to) and could instead provide HMRC with details of their development costs incurred or any patents that have been applied for or granted.
HMRC looks closely at the (potential) receipt of royalties and licence fees, as it is a part of the trade of many EIS companies and a frequent area of concern. As a result, it’s always best to provide HMRC with as much information as possible on the nature of any royalties and licence fees, such as clearly explaining in a business plan that licence fees are generated from IP that the company has developed on its own or created the majority of.
If you are considering EIS funding for your company, you should try to be mindful of whether there are any pitfalls you could fall into, although some can be much harder to spot than others! If you have any queries on EIS please contact our team.