Tax Talk: The Enterprise Investment Scheme (EIS)
Earlier this year, the Office for Budget Responsibility suggested that up to £180bn of “excess savings” had been recorded by households over the course of the pandemic, a value that has likely increased since. As we return to normality, struggling small businesses are seeking to raise investments to grow their businesses, and there are a vast number of start-up companies also seeking funding to pursue new opportunities.
If only there were a way to align these excess savings with those businesses who need funds, in a manner that potentially gives significant tax benefits…
The schemesEIS has been in place since 1993, having replaced the Business Expansion Scheme which gave similar reliefs. The Seed Enterprise Investment Scheme (SEIS) is a more recent relief (2012) for investments in even smaller stage companies. The tax reliefs offered to qualifying investors in these companies are as follows.
- An individual can claim 30% income tax relief on an annual investment into EIS of up to £2 million. This can be claimed in the tax year of investment or carried back into the previous tax year.
- For SEIS, this tax relief is increased to 50%, however, the annual investment is limited to £100,000 in any tax year. Like EIS, this relief can be carried back to the previous year.
- EIS/SEIS shares must be held for a minimum of 3 years, otherwise any tax relief received must be repaid to HMRC. After 3 years, the tax relief is permanent, whatever happens to the Company thereafter.
Capital Gains Tax (CGT)
- Once EIS/SEIS investments have been held for three years, CGT will not be due on any gain at the time of a subsequent disposal.
- CGT due on a different asset can be deferred by the amount subscribed into EIS shares. This can be on assets disposed of 36 months prior to, or 12 months after the investment into EIS.
- This gain is frozen and will become chargeable at a later date, for example when the EIS shares are sold.
SEIS reinvestment relief does not defer the gain, instead it exempts an amount of the gain from CGT provided the shares are held for at least 3 years.
- The maximum gain that can be exempt is 50% of the qualifying SEIS investment.
Inheritance Tax (IHT)
- Shares held in EIS/SEIS companies will normally qualify for 100% Business Property Relief (BPR) if held for at least 2 years.
- A BPR qualifying asset will not be liable to IHT at death.
- If an EIS/SEIS investment performs poorly and you realise a loss, you may be able to claim loss relief.
- The capital loss is reduced by any income tax relief already obtained under EIS or SEIS which has not been withdrawn[TH3] .
- The capital loss on EIS/SEIS can be claimed against income in the tax year of disposal, the previous tax year, or against chargeable gains provided all qualifying conditions are met.
What’s the catch?Investments in EIS and SEIS businesses are inherently a significant investment risk. The reliefs exist because these companies struggle to raise funds to grow their business due to the significant risks surrounding their businesses.
The relief exists to effectively discount the cost of investment for an investor in respect of these inherent risks. However, serial EIS investors will still expect many investments to fail, and lose their money, for every Unicorn that they find.
- Only businesses carrying on certain trades qualify for EIS and SEIS. Trades that carry a low risk of failure are excluded from the scheme.
- You cannot be connected with the company that you want to invest in. That means that neither you nor certain family members can be employees, and together you can’t own more than 30% of the company.
- The relief is targeted at small and growing businesses only and these businesses must prove to HMRC that the investment funds will be wholly used against costs in the first two years after being raised.
- EIS and SEIS shares can only be issued in independent companies, and generally where the liquidity of the shares is low – you may struggle to find a buyer for your shares in the future unless there is a takeover or IPO.
- Companies issuing shares under SEIS or EIS cannot provide any form of risk protection to the investor in respect of their capital. If they do, relief is not available. Accordingly, only Ordinary Shares issued can qualify for relief.
Do your homeworkIf you’re considering making investments in EIS companies, as with any investment opportunity, you need to speak with an independent financial advisor to make sure that the decision is a right one. Some tips are as follows:
- Never invest more in EIS shares than you can afford. If you have cashflow issues in the future, selling your EIS shares to raise funds may not be possible.
- Don’t let the tax relief blind you from the investment potential of the company. An investment into a failing company is still a bad investment, even with an Income Tax discount.
- You can’t get more Income Tax relief in a tax year than Income Tax you are otherwise liable to. You may therefore need to spread significant investments over multiple tax years.
- Check that the Company understands their responsibilities in respect of EIS. EIS relief has many conditions and processes for the company to follow, and can fail where a Company doesn’t follow the rules, with the Investors losing their tax reliefs.
- If EIS relief is important to you, check that the Company qualifies. The company can seek advance approval from HMRC by setting out the relevant facts of the company. If a company received this clearance some time ago, check that it remains relevant. The last thing you want is to invest thinking you’ll get a tax repayment, only to have it refused.
How we can helpIf you’re considering making investments into EIS Companies, and you want to know how this will affect your tax position, or whether the Company qualifies – speak to us and we can help. Note however that we cannot assist you in making an investment decision.
And if you’re running a business that is looking for new investment, watch out for a future tax talk article that considers EIS relief from the Company viewpoint.