Tax

The Enterprise Investment Scheme (“EIS”) is designed to encourage investment in certain early stage UK businesses by offering individual investors both income tax and capital gains tax reliefs. Another, similar scheme – the Seed Enterprise Investment Scheme (“SEIS”) – is targeted at encouraging investment in start-up businesses. Given the potential to attract greater investment as a result of EIS (and SEIS), qualifying businesses will often consider whether the resulting reliefs would be available to their investors. However, there are a number of detailed requirements that need to be met by both the investor and the business and, if any one of those requirements is not met, the relevant scheme will not be available and investors will be unable to access the reliefs.

In a previous Weil blog post we discussed one critical requirement concerning the timing restrictions for an investment which, in the case of EIS, is generally seven years following the first commercial sale. In this blog post, we discuss a further timing requirement in respect of EIS recently considered by the UK First-Tier Tax Tribunal (“FTT”) in Putney Power Ltd and Piston Heating Ltd v HMRC.

Putney Power Ltd and Piston Heating Ltd v HMRC

Background

Putney Power Ltd and Piston Heating Ltd (together, the “Appellants”) were intending to construct heat and power energy centres for the purposes of commencing their trade of generating and selling electricity (the “Trade”). The Appellants issued shares on 4 April 2016 (the “Issued Shares”) with the intention that the individuals subscribing for those shares would be entitled to relief under the EIS.

One of the requirements to qualify for EIS is that either the company (or a qualifying 90% subsidiary) is carrying on a “qualifying trade” (as defined for EIS purposes) on the date the relevant shares are issued or, if not, is preparing to carry on (or preparing to carry on and then carrying on) a “qualifying trade” which actually commences within two years after the date of the issue of the shares.  

In this case, there was no question whether the Trade was a “qualifying trade” for EIS purposes (as it was agreed by the UK tax authority (“HMRC”) that it was); rather the question was whether the Appellants had commenced the Trade within two years of issuing the Issued Shares – i.e., by 4 April 2018.

By 4 April 2018, neither of the Appellants had completed construction of the energy centres, and so neither of them were producing energy.  However:

• Putney Power Ltd had started construction of the site (work commencing in September 2017 and completed by August 2018) and entered into a number of agreements relating to the Trade, including in respect of the sale of electricity; and
• Piston Heating Ltd had not started construction of the site (work commencing in October 2018, with the plant producing electricity in August 2019) but had entered into certain heads of terms.

By decision of 28 January 2020, HMRC determined that the Issued Shares were not eligible for EIS (that decision being upheld on review on 17 September 2021), resulting in an appeal to the FTT by the Appellants.

HMRC’s position was that the Trade commenced too late, principally because the energy centres were not in fact producing and supplying electricity by 4 April 2018.

The Appellants considered that HMRC’s position was wrong in law on the basis that a trade can commence at an earlier stage than the point at which the trader begins making actual supplies.

Decision

The FTT found in favour of HMRC.

Following a detailed review of the case law, the FTT noted that the question whether a trade has begun for UK tax purposes needs to be answered as a matter of commercial substance, looking at the whole picture and, most importantly, considering what is required to start a trade of the kind in question. The FTT noted that this may mean placing more weight on the commercial reality of a set of arrangements than on the precise legal analysis of contractual rights and obligations.

Having done so, the FTT concluded that “the trading infrastructure must be actually (not just contractually) assembled, so that it can be used to deliver the trading activity, before a trade can be said to have commenced.”

Accordingly, on the facts, as neither of the Appellants had completed the construction of the energy centres prior to 4 April 2018 and therefore could not “deliver” the Trade by that date, the FTT found that the Appellants had not begun to carry on a “qualifying trade” with the result that the Issued Shares were not eligible for EIS.

In reaching that conclusion, the FTT made a number of observations:

1. A trade commences when the putative trader is “open for business”.
2. A putative trader cannot be “open for business” until they are ready to provide the goods or services or carry out the other dealings which form the subject matter of their intended trade. This requires the putative trader to have assembled whatever infrastructure (if any) is necessary for them to provide those goods or services or carry out those dealings.
3. Assembly of the trade infrastructure does not need to have been completed before trading starts as long as the infrastructure is operational (i.e. the trader needs to be able to operate/use it to provide whatever goods or services or carry out the dealings they are concerned with, even if not on the scale or in the manner ultimately planned).
4. Once the trader has assembled their operational infrastructure (if required), they “open for business” by taking a step which exposes them to real operational risk and reward (for example, producing goods “on spec”, buying food for a restaurant or other raw materials, incurring the staff or other costs of opening a restaurant or being ready to provide some other service, with or without a booking or client signed up, contracting to supply goods or services now or in the future).
5. If (as we find was the case here with Putney, but not Piston) a putative trader takes an operational step (of the type discussed in (4)) in anticipation of finishing assembling their trade infrastructure, that will not accelerate the commencement of their trade.

Final remarks

Although the FTT decision here considered the commencement of a trade for EIS purposes specifically, the decision will be relevant to a number of other areas of UK tax where trading requirements are fundamental to the tax analysis. Investors who are seeking to avail themselves of relief under the SEIS will no doubt find the decision interesting, but trading requirements are crucial across many aspects of the UK tax code, affecting individuals, companies and partnerships. Ultimately, whether a trade has commenced or not will be a question of fact applying a multi-factorial evaluation of the circumstances.  With respect to EIS specifically, the case highlights the importance of understanding and complying fully with the EIS conditions where the intention is for an investment to qualify for EIS relief.