Since its introduction in 1994, the Enterprise Investment Scheme (EIS) has been a great support to small and medium sized enterprises in the early years of their lives. The generous tax reliefs that the scheme offers assists in offsetting the high investment risk inherent in early-stage companies. This encourages investment in companies that would otherwise have had great difficulty in raising the funds needed for their businesses to take off.
The qualifying requirements for the scheme are considerable, with the aim of removing those solely seeking to take advantage of the benefits granted. As such, navigating the legislation can be complex, it is therefore unsurprising that so many companies unknowingly fall into one of its traps.
A recent case, which is discussed below, was Hoopla Animation Ltd who fell foul of the ‘no disqualifying arrangements requirement’.
No qualifying arrangements?
The legislation sets out that the share cannot be issued due to or in connection with any ‘disqualifying arrangements’. The arrangements are deemed to be disqualifying if one of the main purposes of involved parties is to secure that a qualifying business activity is being carried on by the company or its subsidiary and that one or more persons (whether or not including any party to the arrangements) may obtain relevant tax relief in respect of the shares issued by the Company and either:
Condition A – As a direct or indirect result of the money raised by the issue being spent as required, all or a majority of it is paid to or for the benefit of a relevant person(s).1
Condition B – Without the arrangements, it would be reasonable to assume that the activities comprising the qualifying business activity would have been carried on as part of another business by a relevant person(s).2
The judgment:
A judgement on the Hoopla Animation Ltd v HMRC was made on 23 January 2025. The appeal was made, following the original ruling that the Company’s issued shares did not qualify as EIS shares as the arrangements were deemed as disqualifying arrangements per s178A of ITA 2007.
The Company appealed to the upper tribunal on the grounds that they considered that the First-tier tribunal had misinterpreted and misapplied s178A of ITA 2007. Their argument centred around the term ‘party to’ within the definition of ‘relevant person’ having been misinterpreted and on the concept of paying an amount ‘to or for the benefit of’ the relevant person not extending to amounts that were received pursuant to arm’s length commercial subcontracting arrangements.
The facts of the case
The Company was incorporated for the purposes of utilising IP in an animation project called “Daisy and Ollie”. The Company’s original shareholder was CHF Media Group Limited, who is a parent company of a group of companies, the CHF Group.
The CHF group had a fund through which third party investors would subscribe for shares in special purpose investee companies each of which held the IP rights to a particular concept or show which had been identified by a creative commercial committee.
It should be noted that the committee was made up of employees from CHF Entertainment Limited (‘Entertainment’) who is a member of the CHF Group.
For the Daisy and Ollie project an agreement was entered into which assigned the current and future rights to IP in the programme concept to the Company.
Entertainment was then appointed by the Company as its broadcast representative licensing to capitalise on 52 episodes, by entering into agreements with third parties in return for a percentage commission of the use of the rights revenue.
On the same day, 01 November 2016, the Company entered into a production services agreement (PSA) with Entertainment. Entertainment was appointed to deliver production services in connection with the production and delivery of 52 episodes in return for £3,944,699. Between March and October 2018, the Company raised £1,130,907.40 by issuing shares to CHF Entertainment and it was this share issue which HMRC disputed. They considered the issue to not qualifying for EIS due to CHF Entertainment being a ‘relevant person’ and it being ‘paid to or for the benefit’ of CHF Entertainment.
Hoopla appealed, as noted above, on the basis that, the First-tier Tribunal had not defined what being ‘party to’ the arrangements meant and additionally on the grounds that the legislative words in s178A, which capture amounts paid ‘in the course of arrangements…to or for the benefit of’ a relevant person, are not meant to capture arm’s length subcontracting commercial payments.
The Upper Tribunal had made a judgement early in 2024 on an appeal by Coconut Animated Island Limited, a cartoon animator owned by the same holdings company, which considered the same points albeit that it was regarding a SEIS investment rather than an EIS investment. Coconut’s appeal was dismissed by the Upper Tribunal.
Hoopla however challenged the analysis of the previous appeal, setting out several criticisms which included the argument that the UT did not separately analyse the statutory context for the words “party to” to appreciate that it required something more than the existence of ‘arrangements.
Following the arguments brought forward by the Company, Judge Swami Raghavan was not convinced that there were any errors in the First-tier Tribunal’s decision or in the Coconut case.
Conclusion
Judge Swami Raghavan ruled that there was no error in the decision of the First-tier Tribunal that the PSA contract conferred benefit on Entertainment and that Entertainment was a relevant person being a person who was “party to” the arrangements which included the PSA contract. There was no reason found not to uphold the decision of the Coconut UT and as such the decision was that Hoopla’s arrangements were disqualifying, and the appeal was dismissed.
Going forward:
The judgement reached shows that the ‘no disqualifying arrangements’ requirement has a very wide scope. It would not be difficult to unknowingly step into this trap, causing the share issue to not qualify for EIS relief and as such it is advised that prior to issuing any EIS shares that the Company reach out to a qualified advisor who can lead you in the right direction to ensure that the Company and the shares issued are qualifying.
Should you have any queries, please do get in touch, we would be happy to assist.
