The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are UK government programmes that help smaller, higher-risk trading enterprises obtain capital by providing a variety of tax benefits to investors who buy new shares in those companies.
Benefits of EIS tax relief
You can claim up to 30% income tax relief on investments up to £1 million per tax year.
Any gain is Capital Gains Tax (CGT) free if the shares are held for at least three years.
Payment of CGT can be deferred when the gain is invested in shares of an EIS qualifying company.
If the shares are disposed of at a loss you can elect that the amount of loss be set against any income tax of that year or of the previous year.
Reasons to invest in EIS scheme:
High growth potential
An EIS investment can allow investors to have access to firms they might not otherwise be able to access, as well as companies with the potential to grow in value.
Support UK growth
By investing in an EIS, investors are assisting innovative smaller businesses in creating jobs, wealth, and economic growth throughout the United Kingdom.
Tax incentives
As an incentive for taking on more risk, there is a bundle of attractive tax breaks available. Upfront income tax relief, tax-free capital gains, loss relief, capital gains tax deferral, and inheritance tax relief are all examples of these reliefs.
Complements long-term investments
An EIS can be used to supplement other long-term investments such as ISAs and pensions by providing a distinct risk profile.
What tax reliefs are available?
Income tax relief
Investors can claim 30% income tax relief on EIS investments. This means that if someone invests £1,000,000 in a tax year, they can claim income tax relief of £300,000 in the tax year in which the funds are invested. However, it is possible to treat an investment as if it were made in the previous tax year and benefit from income tax relief against the income tax liability in that previous tax year.
It's vital to keep in mind that income tax relief is applied to the investors' tax liability. This means that the relief can only decrease the investor's burden to zero, and that no unpaid tax may be reclaimed from HMRC.
Loss relief
Loss relief permits an investor to deduct a loss on their EIS shares from their income for the current or prior tax year, or from their capital gains for the current or future tax years.
To qualify for loss relief the value of an investment when it is sold has to have fallen below what is referred to as the effective cost. This is the amount invested less the income tax relief claimed. For example, if £50,000 was invested and £15,000 income tax relief was claimed, the effective cost of that investment would be £35,000.
If the effective cost is £35,000 and the shares are sold for £25,000, the effective loss is £10,000. So, for a higher rate taxpayer, if loss relief is claimed against income, the amount of income tax that could be saved/reclaimed is £4,000, (£10,000 @40%) or if loss relief is claimed against capital gains, the amount of CGT that could be saved is £2,000 (£10,000 @ 20%).
Deferral relief
Deferring CGT on a capital gain (known as deferral relief) on any asset is feasible if the EIS investment is made up to one year before or three years after the capital gain.
The capital gain, not the proceeds of sale, should be invested for deferred relief purposes.
The gain will be deferred until the earlier of any of the following events:
The EIS shares are sold (otherwise than to a spouse/civil partner);
The company ceases to qualify within three years of investment;
The investor ceases to be a UK resident within three years of investment (unless it is because of working temporarily abroad and the investor becomes resident in the UK within three years of leaving and still holds the shares on their return).
When the deferred gain resurfaces, it will be subject to the CGT rate in effect at the time, albeit the capital gain can be further deferred by reinvesting in a new EIS-qualifying investment. However, if the investor owns the EIS shares when he or she dies, the deferred gain will be lost.
Disposal relief
If the shares are sold for more than what the investor paid for them and the investor obtained income tax relief on the original investment and none of that relief has been withdrawn, there will be no CGT tax due if the shares are sold for more than what the investor paid for them. This means that the company must have claimed income tax relief and must have remained EIS qualifying for at least three years.
Business relief
If the investor has held the shares for at least two years, the value of the shares should benefit from 100% business relief, which practically implies the value of the shares will be free of IHT when the investor dies. Even if the EIS company loses its qualifying status, the shares can still qualify for IHT business relief if it remains an unquoted trading company that is carried on for profit (and is not "wholly or mainly" dealing in securities, stocks or shares, land or buildings, or in the making or holding of investments).
Case study - EIS Tax Relief
Martin is an investment banker and earns £150,000. He has recently sold a portfolio of stocks and shares and incurred a capital gain of £180,000.
Given Martin’s earnings, he would lose full entitlement to his personal allowance. As a reminder the personal allowance is reduced by £1 for every £2 once total income exceeds £100,000. This means that for the current tax year the personal allowance is fully lost once total income is in excess of £125,140.
With regard to the capital gain, the whole amount after taking account of his CGT annual exemption (AE) of £12,300 - i.e. £180,000 – £12,300 = £167,700 - would be taxable at the CGT higher rate, so 20%.
Martin’s tax position is therefore as follows:
Income            £150,000
                                  Â
£37,700 x 20%      £7,540       Â
£112,300 x 40%     £44,920
                                  £52,460
Â
Capital gain       £180,000
less AE            (£12,300)
                                  £167,700
£167,700 x 20%   £33,540
Total tax = £86,000
Martin is looking for ways in which he can carry out some planning in order to reduce the amount of tax payable.
After seeking some advice, Martin decides to subscribe for new ordinary shares in an EIS as he is aware that this type of investment would enable him to defer his capital gain and also benefit from income tax relief against his tax liability.
Martin decides to use his annual exemption and defer his taxable capital gain of £167,700 into an EIS.
Martin’s revised tax position is therefore as follows:
Income               £150,000
                                   Â
£37,700 x 20%         £7,540   Â
£112,300 x 40%        £44,920
                                       £52,460
Less income
tax relief at 30%    *(£50,310)
                                        £2,150
*£167,700 x 30%
Total tax = £2,150
Had Martin deferred his whole capital gain he would have benefitted from income tax relief of £54,000 (i.e. £180,000 x 30%). However, as mentioned above, he can only benefit from income tax relief based on his actual tax liability which is £52,460. Â
The company must remain qualifying and Martin has to hold the shares for at least three years otherwise the income tax relief would be withdrawn.
Ordinarily, on future sale of the EIS shares, Martin’s deferred here gain would come into charge, whereas if he retains the shares until death the deferred gain is fully eliminated. And, provided the company is still a qualifying trading company, under current legislation the shares will qualify for 100% business relief and thus be free of IHT.
This article provides a broad overview of the various tax reliefs available. However, given that investment is being made into smaller, often new companies, EIS investment does carry its risks, so it is vital for clients to fully understand the risks involved as well as the benefits prior to making such investment decisions.