Digi and Tech Start Ups – 5 Tax Incentives and Reliefs You Should Know

Despite Brexit uncertainty, the outlook is bright for the UK tech sector. The Tech Nation Report 2018 has found that the sector is growing 2.6 times faster than the overall economy and London was ranked as the second most connected place in the world for tech businesses behind Silicon Valley. I’m sure many will agree that these are exciting times for digi and tech start-ups throughout the UK.

This sense of positivity is also shared by the government who have made it clear that they foresee technology as a cornerstone of the post-Brexit UK economy. Theresa May has described tech as being ‘a core component in our modern industrial strategy', reiterating the government’s aim to invest in ‘the best innovations and ideas’ to develop the UK into a ‘tech nation’. In the recent 2018 Budget announcement, Philip Hammond has echoed this sentiment, pledging £1.6 billion to fund “advanced technologies” like quantum computing and artificial intelligence.

To support this part of our modern industrial strategy, the government offers several tax incentives to promote and encourage innovative and pioneering businesses. These incentives are extremely useful to digi and tech companies and can be used to improve cash flow, incentivise key staff members and attract investment across all stages of the business’ lifecycle.

There is a large volume of tax incentives available to technology companies; however, five in particular are specifically useful to the digi and tech sector. Each of the incentives can be especially useful for particular objectives and phases of a business’ growth.

1) Start-Up Phase – Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

Technology companies are particularly reliant on external investment in the start-up phase and using EIS or SEIS can make your business a more attractive prospect for external investors, helping you secure the vital capital needed to finance development.

The EIS scheme provides several tax benefits to the investor, including an income tax reducer at 30% of the amount invested up to £1 million and an exemption from capital gains tax if the shares are held for three years. This means that investment in an EIS qualifying company can be an appealing prospect to investors and there are steps you can take to increase your chances of securing investment through this scheme.

The scheme is targeted at independent, UK-based unquoted companies with gross assets of less than £15 million, fewer than 250 employees and conducting a qualifying trade. Advance assurance is available from HMRC confirming that your company qualifies for EIS and it is recommended that this is obtained. This provides comfort to potential investors and many will insist on advance assurance being in place before making an investment.  

If your company is less than two years old, you may be eligible for SEIS which provides a higher rate of income tax relief at 50% for investors on investment amounts up to £100,000.

2) Development Phase – Research and Development Tax Relief (R&D)

R&D is a generous relief which allows companies to claim an enhanced deduction from their taxable profits if they are working to resolve a technological uncertainty. The enhanced deduction can result in a tax saving of nearly 25% of the qualifying R&D expenditure incurred. The vast majority of tech start-ups are likely to have at least some form of qualifying R&D activity.

What makes R&D particularly valuable to tech start-ups is the ability to claim a cash credit if the company is loss making. As most tech start-ups do not have a source of income until their product is launched, this can provide a significant cash injection to the business to assist with cash flow and working capital needs.

3) Development Phase – Enterprise Management Incentives (EMI)

A key issue that tech companies face is retaining key staff members, especially developers. There can be a concern that a developer who is heavily involved in a project may choose to leave the business before the development is complete, which can cause a significant amount of disruption and delays to the entire project.

An effective method of alleviating this risk is to incentivise staff through company share options. These have the benefit of incentivising employees to remain with the business for the long term with little cash cost to the business. Through issuing options which vest upon an eventual sale or flotation, it is possible to tie in key personnel to reduce the risk of disruption to a product’s development.

There are several HMRC approved share option schemes, the most popular of which is EMI. The benefit of using EMI is that any gain on the options during the vesting period would be taxed under capital gains tax as opposed to income tax, meaning the employee will be taxed at a lower rate. The company can also claim a corporation tax deduction on the market value of the shares issued to satisfy the options, despite there being no income tax charge to the employee.

4) Launch Phase - Patent Box

Once a tech start-up has completed its development, it is likely that the company will seek to protect its intellectual property through filing a patent. If this patent meets specific criteria, it could be a qualifying patent for the patent box regime.

The patent box is a tax relief where a company can opt to have all profits arising from the use of a qualifying patent to be taxed at a lower rate of corporation tax. All profits arising from the use of the patent will be taxed at 10% so this relief can result in significant year-on-year tax savings for technology companies once their product has been developed and launched.

5) Exit Phase - Entrepreneur’s Relief

A key concern for any business owner is ensuring that they achieve optimal rewards upon an eventual exit from their business. This is especially true for digi and tech start-ups as these businesses have often been built from the ground up, meaning that business owners can face significant capital gains tax liabilities on an eventual exit.

Entrepreneur’s relief is a method to pay a lower rate of capital gains tax on any gains arising from a disposal of all or part of a ‘personal’ company. All gains arising on such a disposal would be taxed at a flat rate of 10% as opposed to the standard rate of capital gains tax at up to 20%.

There certain conditions to fulfil to be eligible for entrepreneur’s relief, including a minimum shareholding. It is therefore important to ensure that shareholdings are not diluted through external investment in the early stages of the business as this may affect eligibility for entrepreneur’s relief upon an exit.

This has been just an outline of some of the tax incentives available to the growing technology sector and how they can be applied to support companies to meet their goals and ambitions at each distinct phase of the business lifecycle.

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