EIS: What is an Enterprise Investment Scheme?
- The Enterprise Investment Scheme (EIS) has provided tax advantages for investment in unlisted companies since 1 January 1994.
- Enterprise Investment Schemes are a government led programme designed to provide a range of tax reliefs for investors who subscribe for qualifying shares in qualifying companies.
- Qualifying Companies must be unquoted companies or listed on the Alternative Investment Market (AIM). They must not carry on certain trades including dealing in land, commodities, futures, shares, securities or other financial investments. Most financial activities are excluded. Most property-based trades are excluded such as property development, hotel management, the operation of nursing homes, farming and forestry enterprises. The trade carried on must be wholly or mainly in the UK.
The Tax Advantages
Income tax relief is given at 30% on qualifying investments of up to £1,000,000 in a tax year. There are a number of EIS tax reliefs available:
- 30% Income Tax Relief- 30% income tax relief is granted on qualifying investments made, up to a maximum of £1 million for the 2014/15 tax year and £1 million if carried back to the 2013/14 tax year. In order to retain this relief the investment must be held for at least three years. The tax relief is generated as and when the money is employed by the qualifying companies.
- Capital Gains Tax (CGT) Deferral – If you’ve made a capital gain that is taxable, it can be invested into EIS shares and the capital gain will be deferred for the life of the investment.
- You should note that :
- Capital gains tax deferral will apply as and when the investments into qualifying companies are made
- The gain must be invested into qualifying companies within three years from the date that it was realised (i.e. you can even reclaim tax you have already paid)
- If you die while your money is invested, the tax due on your capital gain will die with you
- Loss Relief- Loss relief is one of the most compelling features of an EIS because the impact of losses at an individual company level is reduced. This loss relief significantly improves the overall post-tax risk/return profile of the investment. – see drop down below for further details.
- 100% Inheritance Tax Relief – Provided funds remain deployed in the underlying trades, the investments should be eligible for Business Property Relief (BPR). Investments which qualify for BPR are excluded from an investor’s estate for Inheritance Tax purposes, if held for a minimum of two years (and at time of death). This two year period applies from the date the money is invested into qualifying companies.
- Tax Free Growth –
- Where gains arise from holdings within the portfolio there is no capital gains tax.
Obtaining Income Tax Relief
Under EIS rules, the product provider will have to wait until each company has been trading for four months before they can apply to HMRC for the certificates which will enable you to claim your tax reliefs. Once they have applied for them it usually takes two months before they have the completed forms ready to send to investors. So it’s likely to take up to twelve months, from the date on which they make investments on your behalf into the qualifying companies.
The relevant date for income tax relief, from a tax year perspective, is the date on which investments are made into each qualifying company, rather than the date on which you invest into an EIS fund or portfolio service.
You cannot claim tax relief until the company sends you a form – called EIS3. If you invest through an Approved EIS Fund you will receive a different form – EIS5.
Your claim can be made via your self assessment tax return for the tax year in which the shares were issued. If the shares were issued in a previous year, and/or if the claim is for capital gains deferral relief, the claim part of the form EIS3 must also be completed and sent to your tax office.
If you have an EIS3 that would allow you to claim income tax relief in the current tax year, you can request a change to your PAYE tax code, or an adjustment to any self assessment payment on account due. You will still have to make the claim itself on your tax return when you obtain it. Full use of these tax advantages will depend on individual circumstances and if you’re unsure of your own potential tax liabilities, you should seek professional advice from a qualified tax adviser. Please remember that tax rules and regulations are subject to change.
The tax reliefs are available to investors who directly invest into EIS qualifying companies.
In order for a company to qualify for EIS relief it must be unquoted or quoted on the Alternative Investments Market (AIM) or the PLUS markets. There are also a lot of trades that are excluded – these tend to be those that look like financial services or are property based. So, dealing in shares, securities, futures, commodities or other financial instruments would be excluded. Likewise dealing in land, operation of hotels or nursing homes, farming and forestry enterprises are all excluded.
A summary of the qualification criteria is provided below:
- The investment must be into new shares (therefore an investor can’t simply buy existing shares).
- The company is an unquoted company at the time the shares are issued.
- The company is not controlled by another company.
- The company has fewer than 250 employees.
- The company has gross assets that do not exceed £15 million before investment, or £16 million after investment.
- The investee company uses the money raised within 24 months.
- Any investment of EIS (or VCT) funds does not exceed more than £5 million in any one company in any one year.
Different Types of EIS
- Single company EIS
- EIS portfolios
- Approved EIS funds
- Seed EIS
Single Company EIS
A single company EIS is often the highest risk as it invests in one individual company. An investor’s fortunes will depend upon the performance of that one underlying company. Usually unlisted, there will often be no exit route until the company is either floated or sold.
EIS portfolio (or Unapproved EIS Funds *)
An EIS portfolio is generally a managed service that invests in a number of underlying single EIS investments – often up to 20 different companies. It will be professionally managed, normally on a discretionary basis, and EIS relief is available as each individual investment is made and not when the money is placed into the portfolio service.
Approved EIS fund *
An approved fund will have four or more different underlying companies. Clearance is received from HMRC prior to the fund launch. This has no bearing on the underlying investments, however it means the income tax relief is given in the tax year the fund closes. CGT deferral is not available until the manager has made the underlying investments. An approved fund has a requirement to invest 90% of funds raised within 12 months of when the fund closes to new business.
Generally, EIS investments are classified as high risk investments. However, recently a number of EIS investment managers have launched EIS products that are focused on investing into businesses focused on capital preservation.
Typically these may include the following characteristics:
- The use of insurance to reduce risk
- Substantial backing with easily valued assets
- Predictable (bankable) revenue streams
- Creation of intellectual property of known value
- 100% owned by investors with lower risk appetite
- Fund manager remuneration aligned with capital preservation.
This opportunity is likely to be suitable for UK resident individuals and trusts who are looking to:
- Take advantage of income tax relief
- Defer payment of capital gains tax
- Shelter investments from inheritance tax
- Harness the potential for significant tax free capital growth in today’s financial markets
- Diversify their existing investment portfolio
- Find a complementary solution to pensions
EIS’s are considered to be long term investments designed primarily for high net worth individuals or sophisticated investors who understand the higher risks which they may carry and have the capacity to sustain any losses. You should answer the question section to gauge your understanding and whether you match either status regarding this investment but ultimately it is your decision, and responsibility, if you chose to proceed.
An Enterprise Investment Scheme, EIS, is a tax efficient scheme for investing in small businesses. It’s in the government’s interest for small businesses to succeed, but companies often find it difficult raising capital. Banks won’t lend and most institutional investors need to invest larger amounts of money often leaving the private investor (or business angel) as the only option. To encourage private investors, the government introduced generous tax incentives in exchange for locking investors in for a minimum of 3 years, although in practice the investment time horizon is much longer. The longer the timescale, the more risk there is to the capital due to inflation.
An EIS can be as simple as a single company investment or it could be a managed service or EIS fund offered by an investment manager (often a venture capitalist). However the investment is made, it is ultimately an investment into one (or a number) of small unquoted businesses.
Neither single company EIS or managed EIS services are traded on a stock exchange so withdrawing cash can be difficult or, at times impossible – therefore EISs should only be considered by sophisticated, long term investors. An investor’s capital is often only returned when the underlying investment is sold. EISs are at the top end of the risk scale and are only suitable for sophisticated wealthy investors who can afford to lock money away for the long term.
Relief is potentially available from income tax, capital gains tax and inheritance tax, but these rules can change. As with any investment, never let the tax tail wag the investment dog. Just because the tax breaks are exciting, always ensure the full risks and potential rewards of an investment are understood.
Please remember, EIS are higher risk investments and should only be a consideration for those who can afford to take the risk, their value will fall as well as rise. They are primarily intended for sophisticated investors or high net worth individuals. You should hold them for the long term, but you could still get back less than you invested. Please remember, the value of tax savings will depend on your circumstances and tax rules can change over time.
Key risks for an EIS
- Deemed by the FCA as a higher risk investment
- locks investors in for a minimum of 3 years
- EIS’s are usually long-term investments (5-10 years)
- Risk is to the capital due to inflation
- Investment into one (or a number) of small unquoted businesses
- Returns are not guaranteed
- Capital is often only returned when the underlying investment is sold
- Value of tax savings will depend on your circumstances and tax rules can change over time
- Rates of tax, tax benefits and allowances may change from time to time and are not guaranteed
- Tax treatment is dependent on individual circumstances and may be subject to change in the future
- Past performance is not a guide to future performance and may not be repeated
- The value of shares can go down as well as up and you may not get back the full amount invested
- An investment in an EIS may be higher risk than investing in securities listed on the London Stock Exchange official list
Loss relief is one of the most compelling features of an EIS because the impact of losses at an individual company level is reduced. This loss relief significantly improves the overall post-tax risk/return profile of the investment.
For most investments the tax man gives with one hand and takes with the other. So when normal shares fall in value investors have an allowable loss, but then they face capital gains tax (CGT) when they go up in value. Some specific investment types (such as ISAs or VCTs) are free from CGT when they go up in value, but understandably there is no tax relief if they go down in value. Both situations seem consistent.
EIS, however, is different. Gains are not taxed, but losses attract relief.
Each individual holding is assessed separately for loss relief. This means that any holding that has fallen in value at the time of sale will qualify for loss relief, irrespective of the overall portfolio performance. Even if only one holding within a portfolio of ten investments falls in value, investors are entitled to loss relief on that one holding.
What’s more, investors can choose whether that relief is set against other gains (then or in the future) or against income tax in that year (or for the year before). So they get to decide which use of the relief would be most beneficial to them, potentially recovering up to 50% income tax if an investor pays it at that rate.
When can I Sell
EIS investments will be in to companies which are not readily realisable investments. You should be prepared to retain an EIS investment for at least three years or you will lose any initial reliefs claimed.
Once the company in which you are invested has been trading for at least three years, the following options may become available to you to realise your investment at a later date:
- Disposal of your shares to a third party or back to the company
- Management buyout
- Trade sale
- Liquidation of the company on a winding up