Disqualifying arrangements prevent SEIS relief

In Coconut Animated Island Limited v HMRC [2022] TC08575, the First Tier Tribunal (FTT) held that despite meeting the risk to capital and qualifying activities conditions, there were disqualifying arrangements in place that meant that HMRC were right to refuse to issue a Seed Enterprise Investment Scheme certificate.

• CHF Media Group Limited (CHF MGL) had a fund where investors subscribed for shares in newly incorporated special purpose investment companies that in turn held the rights to particular television shows.
• Mr Fenna, Creative Directive of CHFE, a group company, pitched an idea of his own, which was then picked for investment by the fund.
• The appellant 'Coconut', was incorporated and Mr Fenna sold the IP rights to the company for £1 and 10% of future net profits. He also began working for it in order to progress the project.
• In October 2017, Coconut requested Advance Assurance under the Seed Enterprise Investment Scheme (SEIS) and HMRC confirmed authorisation would be given. 
• 'A' shares in the company were held by CHF MGL and 'B' shares were held by a group nominee company for the investors. The B shares were issued over the course of several months from December 2017 to April 2018.
• A Production Service Agreement (PSA) was put in place between the appellant and CHFE, who were to provide the majority of the services required by the appellant to carry on its trade.
• Upon submission of compliance statements regarding the issue of the B shares, HMRC issued compliance certificates for the shares issued prior to 15 March 2018 but refused to issue certificates for subsequent share issues. This was due to the introduction of the Risk to Capital condition that had been enacted as part of the SEIS qualifying conditions.
• The appellant appealed to the FTT.

The FTT considered there to be three issues to be decided based on HMRC's submissions:

• Had the appellant failed the Risk to Capital condition by having no objective to grow and develop the trade in the long term?
• Did the appellant enter into 'excluded activities' which would prevent it from carrying on a Qualifying Trade?
  • The receiving of royalties or licence fees is an excluded activity unless it is attributable to intangible assets created by the company.
• Had the appellant failed to meet the general requirements regarding the issue of the relevant shares, due to 'disqualifying arrangements'?
  • The definition of 'arrangements' is wide.
  • The main, or one of the main purposes of the arrangements, needs to be securing that the business activity was a qualifying trade.

The FTT found that:

• There was a clear objective to grow the trade.
  • The appellant operated a credible commercial model, with realistic projections.
  • The lack of an objective to increase employees was not relevant. The use of sub-contractors was commercially sound, as also held in CHF Pip! Plc v HMRC [2021] TC08305 and Inferno Films v HMRC [2022] TC08472.
  • The aims of the investors to exit after five years were not to be confused with the long-term aims of the company.
• The IP was created by the company and the royalties were not excluded activities.
  • The rights assigned by Mr Fenna were of nominal value. 
  • There was growth in value as recognised in the accounts under GAAP, which belonged to the company.
  • The use of sub-contractors to grow the value did not prevent this.
• There were disqualifying arrangements in place: these prevented the general requirements from being met.
  • The arrangements included the incorporation of the company, acquiring IP, raising finance and using those funds to pay for the services through which the trade was carried on.
  • The PSA was the only way the appellant could carry on its trade.
  • Half of the appellant's budget was paid to CHFE, which was clearly connected to the arrangements by being part of the CHF MGL group.
  • It concluded that the whole or majority of the money raised was paid to or for the benefit of a person party to the arrangements.

The FTT held that whilst the appellant met the Risk to Capital condition and did not undertake excluded activities, there were disqualifying arrangements in place, so the company did not qualify for SEIS. The appeal was dismissed.

UPDATE: This case has been appealed to the Upper Tribunal.

Useful guides on this topic

SEIS: Seed Enterprise Investment Scheme
When can SEIS relief be claimed?  What are the conditions for SEIS relief?  What are the benefits of SEIS relief?

SEIS & EIS: Qualifying trades and activities
What is a qualifying trade or activity for Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) relief? Which trades do not qualify for relief? What are excluded activities?

Risk to capital: EIS, SEIS and VCTs
This is a freeview 'At a glance' guide to the risk-to-capital condition for the Enterprise Investment Scheme (EIS).

EIS or SEIS: Advanced assurance from HMRC
This is a freeview 'At a glance' guide to Advance Assurance for EIS and SEIS. 

External link

Coconut Animated Island Limited v HMRC [2022] TC08575