In the first of a series of blogs, Roger Phillips, Director in PM+M’s tax team, explores the Enterprise Investment Scheme (“EIS”).
In this article, Roger looks at the tax reliefs available to individuals who are looking to invest under the EIS.
Watch this space for future articles where Roger will delve into which companies might qualify for attracting EIS investment, the procedures and processes of how companies might go about obtaining approval from HMRC before they go to market to look for investment, and other venture capital reliefs, such as the Seed Enterprise Investment Scheme.
Background to EIS
The EIS was introduced by the government in 1994 as a way of small start-up companies attracting finance by way of equity investments – i.e. raising money by issuing new shares to external investors.
Needless to say, EIS has proved a great way for small start-ups, as well as more established businesses who are looking to scale-up or enter new markets, to raise finance and achieve their goals of growth.
The tax rules offer generous incentives for individual EIS investors, in the form of income tax and capital gains tax (CGT) reliefs. These reliefs are:
- Income tax relief
- CGT exemption
- CGT deferral relief
- Income tax loss relief
- In certain circumstances – inheritance tax (IHT) relief
We consider each of these in some more detail:
Income tax relief
An investor can subscribe up to £1m[1] in EIS investments per tax year and receive income tax relief of 30% of the amount of their investment.
For example, someone with earnings of £100k would normally have an income tax liability of around £27k.
If they were to make an EIS investment of £90k, this would enable them to reduce that tax liability by £27k (£90k @ 30%).
Assuming their income tax liability had been withheld from their earnings via PAYE, the individual would, on the making of a claim to HMRC for EIS relief, be due a refund of £27k from HMRC.
It is also possible to “carry back” the income tax relief, by way of an election, to the tax year prior to the investment.
Therefore, if someone does not have sufficient income tax to use the relief in a single tax year, they might be able to obtain the relief against two tax years’ worth of income.
Before they can make their claim for EIS relief, they must have been issued with an EIS3 certificate from the company – which itself must meet some fairly stringent conditions.
CGT exemption
Where an investor qualifies for EIS income tax relief, they will also qualify for CGT relief after holding their shares for a 3 year period, provided they have claimed their EIS income tax relief (note that this income tax claim is vital).
The exemption allows a tax free sale of the EIS shares, providing its more than 3 years after their acquisition.
Normally, CGT would be paid on capital gains on share gains at between 10% and 20%.
The above assumes that the company continues to qualify as an EIS company throughout the 3 year period from the date the shares are issued (we will look at this in a later article).
Again, the EIS3 certificate is required before the claim can be made.
CGT deferral relief
In addition, EIS offers the opportunity for individuals to “defer” any capital gain that they might have realised on the disposal of other assets, e.g. shares or property, by reinvesting proceeds into an EIS investment in the 3 years from the date of realising that gain. This is known as “CGT deferral relief.”
CGT deferral relief may also apply if a qualifying EIS investment has been made in the 12 month period prior to the date of the other gain.
Therefore, if you have realised a capital gain, you can reinvest some of the proceeds into an EIS investment and defer the CGT until a later date (broadly when you sell or transfer the EIS shares, or if you emigrate).
You only need to reinvest an amount equal to the gain to defer it in full, and in fact you can reinvest less. You might do this to preserve the CGT annual exempt amount or to make use of any available capital losses that you might have. Or you might simply decide you only want to make a small EIS investment.
The level of CGT deferral relief that can be claimed is unlimited (unlike EIS income tax relief which is capped), and the relief may be available even if the individual would not qualify for EIS income tax relief in their own right – i.e. the rules to get CGT deferral relief are less strict than those relating to income tax relief and the CGT exemption.
Of course, if EIS income tax relief/the CGT exemption can be accessed, they are certainly worth having.
Once again, the EIS3 certificate is needed to make the claim.
Income tax loss relief
Given the inherent risky nature of EIS investments, there are inevitably cases where investments do not succeed, so rather than a CGT free sale on a large gain, you might be in a position where your investment has become worthless so that you realise a loss.
If this is the case, all is not lost, and further relief may be due – either in the form of a capital loss, which could be used against gains of the tax year of the loss or beyond, or alternatively, in the form of income tax relief, which is generally more valuable as this can provide relief of up to 45% of the net loss.
Click here to find out more about income tax loss relief in our recent blog.
Inheritance tax (IHT)
In addition to the income tax reliefs and CGT reliefs discussed below, shares in EIS companies may often (but not always) also qualify for IHT business property relief once they have been held for a period of 2 years.
If this relief is available, this would mean that the value of the shares would be exempt from IHT if an individual were to hold them in their estate at death after a 2 year holding period.
Individuals who will not qualify
The rules around EIS are very strict and certain individuals will not qualify for relief in respect of certain investments.
For example, EIS relief is not available to individuals who already hold shares in a company in which they might be looking to make an EIS investment.
Furthermore, EIS relief is not available to those who, along with their associates, hold more than 30% of the company.
Finally, EIS relief does not apply to employees or directors of the company – although individuals may become directors after making an EIS investment in certain circumstances – for instance “angel investors”.
Seek professional advice
In summary, EIS is a government approved scheme which can provide valuable tax breaks for individual investors.
However, the investments are not without risk – and this is the basis on which these generous tax reliefs are offered.
If you are considering making an EIS investment, you should seek both tax and financial advice beforehand as the rules are complex, with many pitfalls, and the investments may not be straightforward.
Future articles
In future articles in this series, we will look at:
- The requirements for the company – not all companies qualify for EIS.
- Which companies might qualify for EIS investment, and which will not?
- What does the company need to do with the money and when?
- How can the company get assurance from HMRC that it will qualify and how does it get its EIS3 certificates for investors?
- What other similar reliefs might be available to investors?
This article is for general information purposes only and in no way constitutes advice. By their nature, EIS investments are inherently risky, and you should always seek independent financial advice before investing. You should also seek tax advice prior to investing.
[1] Up to £2m can be invested in companies which qualify as “knowledge intensive”
