Last month, we wrote about the tax benefits (and the risks) of Venture Capital Trusts (VCTs). While they can be high-risk, they do offer significant tax benefits and can be used by business owners and senior execs to supplement their pension income.
Following on from our examination of VCTs, this month we’re looking at investing in Enterprise Investment Schemes (EIS). What is an EIS? Who can invest? And what are the benefits and risks? Keep reading for answers to these questions and more.
What are EIS investments?
EIS is a tax relief scheme created by the UK government in 1993 to encourage investment into start-ups and early-stage businesses.
As an investor, EIS benefits you by offering potentially significant income tax and capital gains reliefs when you invest in an EIS eligible business.
Since the Enterprise Investment Scheme (EIS) was launched in 1993-94, more than 29,500 companies have received investment and over £20 billion of funds have been raised. FT Adviser calls EIS ‘arguably the most generous tax-efficient investment vehicle available to the UK taxpayer.’
To qualify for the tax benefits available under the EIS you must abide by the following rules:
- You must be a UK taxpayer
- You can’t be connected to the EIS company (for example, as an employee, partner or paid director)
- You can invest up to £1 million in qualifying companies per tax year
- You must hold the shares for a minimum of three years. If you sell or gift the shares within this time, relief clawback will apply
- You can’t carry forward EIS tax relief
- You must buy brand-new shares that are not already available on the market.
EIS tax relief
Some of the main advantages of investing in EIS relate to the favourable tax benefits.
Income Tax Relief
You can claim Income Tax relief up to 30% of the value of your investment. So, if you invest £100,000 you can save £30,000 in Income Tax.
Capital Gains Tax relief
If you hold EIS shares for at least three years, any capital gain realised on the disposal of the shares will be free of Capital Gains Tax (as long as Income Tax relief has been given).
Capital Gains Tax deferral relief
This relief allows you to defer Capital Gains Tax on a chargeable gain arising from the disposal of any asset up to three years before, or one year after, an EIS investment is made. You can claim deferral relief against those gains at up to 28% (for gains on residential property or carried interest) and up to 20% on other gains.
Inheritance Tax relief
You can generally claim Inheritance Tax relief of 100% after you hold your EIS shares for at least two years. This means that any liability for Inheritance Tax is reduced/eliminated in respect of these shares unless the shares are listed on a recognised stock exchange.
EIS loss relief
If the business in which you invest performs poorly and you lose money on your investment, you can claim ‘loss relief’.
This loss relief is available at the same rate as the highest rate of Income Tax you pay. So, if you pay Income Tax at a rate of 45%, you can claim up to 45% of your net loss in Income Tax relief.
Here’s an example.
If you make a £50,000 investment and the business entirely fails (so your investment is worth nothing):
- You can claim the 30% Income Tax relief (£15,000 in this example)
- You can claim loss relief on the remaining £35,000 of an amount equal to your tax bracket (in this example that would be 45% or £15,750)
- Overall your total loss would only be £19,250.
When you invest in an EIS, you can treat some or all of the shares as being issued in the previous tax year, as long as you had not reached the limit for the value of EIS shares purchased (£1,000,000) in that year.
Here’s an example.
If you invest £50,000 in an EIS eligible company in the 2019/20 tax year, your Income Tax relief would be £15,000 (30% of £50,000).
You can apply to have that £15,000 carried back to the previous tax year (2018/19) and relieved against your tax in that year (assuming you hadn’t acquired more than £1 million worth of EIS shares in that tax year).
When you invest in an EIS you are investing in a start-up or early-stage business. So, you should be fully aware of the highly risky nature of this type of investment.
There are many risks associated with new businesses:
- The business may be reliant on a small number of key people. Any change in personnel can have a substantial impact on the performance of a company
- The business may not achieve its stated goal
- Your investment could be diluted if the company issues more shares in future funding rounds
- Tax legislation could change, and reliefs may not be available or as generous in future
- Shares could be difficult to sell
- Your investment could fail or be sold at a significant loss.
Overall, it’s important to view EIS as a medium to long-term investment, and it won’t be suitable for everyone. Always speak to your tax and financial adviser before investing.
If you’re interested in EIS, or you want more advice regarding whether this type of investment is suitable for you, please get in touch. Email firstname.lastname@example.org or call us on 01454 416653.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
- Investments are in small, unquoted companies and should be considered as a long-term, high-risk investment
- Legislation, along with the nature and level of tax reliefs is subject to change
- Many EIS involve investment in a single company or sector and therefore should only be considered as a small part of an overall portfolio
- EIS investments should only be undertaken by sophisticated investors who understand, and have given careful consideration to, the underlying investment strategy and associated risks. For help in determining potential investment suitability, professional advice should be sought