Here at ForrestBrown we’ve been aware of one particular positive feedback loop for startups for a while, the tax relief loop. This is more or less how it works, although every company is different and may visit individual steps in a different order.
Step 1 – Investment
The SEIS and EIS that it complements are both extremely attractive schemes for investors. SEIS reliefs are available on a maximum annual investment of up to £100,000 , while EIS reliefs are available on a maximum annual investment of up to £1 million.
Both schemes enable investors to defer former capital gains tax, be exempt from inheritance tax, and be exempt from capital gains tax after having held the shares for three years. For the later, they must also show that they have claimed income tax relief on the shares.
That brings us neatly to the headline figures – SEIS in particular provides income tax relief of up to 50%, or £50,000 per year if the maximum permitted amount is invested, while EIS provides income tax relief of up to 30%, or £300,000 per year.
These schemes are not always applicable as the qualifying criteria are not only notoriously complex but also strictly administered, in large because of the generous tax reliefs.
For instance, due to the tax reliefs available, HMRC is effectively underwriting a large proportion of the investment made by the investor. So, in the worst case scenario of the company failing , the investor has the potential to claim tax relief equal to approximately 2/3rds of the original investment. All of this makes SEIS and EIS companies extremely attractive to angel investors, allowing your business to go further, faster.
If you are able to take advantage of these schemes, it is usually a very good idea to do so.
Step 2 – Innovation & Development
Using the funds you have attracted using smart use of SEIS/EIS funds, you then run into a few challenges in any business. Supplementing the funds received, beginning to smooth out your incipient cash flow and, most importantly, building on your product or service – whether you’re building a MVP, adding extra functionality, or refining and defining your offering in a competitive marketplace.
It’s at this stage of your business that you can use the R&D tax relief scheme to claim up to 32.67p for each £1 you spend on research and development , an enormously significant amount for any enterprise.
Claiming R&D tax relief and R&D tax credits is complex because it’s not just about the numbers. It’s as much about understanding the nuances of what counts as claimable research and development as it is about understanding the tax rules and numbers, and for that you need to have some degree of expertise telling the story, or explaining why you are entitled to any R&D tax relief at all. In some ways this is analogous to the ‘description’ and ‘claims’ portions of a patent application.
R&D tax relief can also be complicated by, for instance, grants and subsidies.
Finally, letting potential angel investors know that you’re planning to claim for R&D costs is a great way of letting them know that you’re already thinking about optimal ways to use their money to get them a return. Together with the potential for complicating factors from an ad hoc financial plan, it may make sense to start thinking about R&D tax credits even when you’re still at step 1 in the process.
Step 3 – Grant Funding
Grant funding is a fairly standard way to raise money for a company, but grants can conflict with R&D tax relief claims. It’s generally best to get advice on the grants that won’t conflict with your tax reliefs or trigger clawbacks.
However, it is very important not to assume that grants and tax reliefs are therefore mutually exclusive. This idea about grants and other state aid is extremely prevalent, but not accurate. There is state aid you can receive, most importantly but not solely de minimis state aid, that will affect your ability to claim R&D tax relief to a lesser extent – just as if you receive the wrong grant at an unfortunate time you could stand to lose vast amounts of R&D tax relief.
The devil, with grant funding, is very much in the details – but the immediate cash injection is extremely difficult to argue with!
Ultimately, you should evaluate the grants available to you on their own merits, taking them seriously as means to trigger the growth phase of your business, but also working out expected effects on R&D tax credits you’ll be able to claim later on.
You can see which grants will be available to and suitable for your business on the government’s website.
Step 4 – Growth
During your growth phase, you can use tax efficient equity schemes to attract and retain effective staff. EMI options offer tax advantages and the opportunity for flexible incentive schemes in order to attract and retain the best staff.
Under an EMI, tax-advantaged share options worth up to £250,000 may be granted to a qualifying employee working for a qualifying company.
These options attract no income tax or National Insurance charge on their grant or exercise. Instead there is only capital gains tax charge at the point the shares are sold, and under an EMI option any gain would qualify for Entrepreneur’s Relief, so the CGT rate would be 10%. As such represent an extremely attractive incentive to ambitious, talented workers who have a strong belief that the company will succeed.
With the most ambitious and talented workers available to your relatively small company, significant growth is much more likely.
Step 5 – Back To Step 1!
You can, of course, seek another round of funding from investors at any time. You will, however, make a far stronger case if you already have:
• Happy, tax-efficient investors from the previous round
• Innovative products
• Government funding
• Strong growth and a motivated team of employees
• Inexplicably high amounts of utility per pound spent
ForrestBrown’s speciality is R&D tax credits, but we can help you plan every step of the process a little better. Get in touch to discuss how we can work together, and we’ll help your business live up to its potential.