The Enterprise Investment Scheme (EIS) is a Government scheme designed to encourage individuals to invest into certain companies, thereby allowing those companies to raise finance and, hopefully, grow. Such encouragement is provided in the form of tax reliefs.
The scheme does come with various rules and conditions. Some apply to the company (ie what qualifies as an EIS company) and some apply to the individual. This blog focuses on the position for individuals.
Summary of tax reliefs
The tax reliefs which are potentially available to an investor are:
- Income tax relief – on subscribing for the shares
- Capital gains tax (CGT) relief – on subscribing for the shares
- Income tax relief – on selling the shares (for a loss)
- CGT relief – on selling the shares (for a gain)
- Inheritance tax (IHT) relief – on owning the shares
More detail is provided below – but please do appreciate that it is only an overview and should not be taken as a substitution for full, professional advice.
The existence of the IHT relief means that investing into EIS shares can be a very useful tool for IHT mitigation, in addition to the other tax benefits which exist.
Subscribing for new shares
The individual must be subscribing for new shares in the EIS company. Such tax relief is not available if existing shares are purchased.
For every £1 of investment, an individual can reduce their income tax liability by up to 30p. This is subject to a maximum annual investment of £1million (or £2million in limited circumstances). However, in order to benefit, the individual needs to have an income tax liability which is at least equal to the amount of relief. For example, if Tom and Jerry each invest £100,000 into an EIS company, they can each potentially benefit from up to £30,000 of relief. If Tom has an income tax liability of £50,000 but Jerry only has £10,000, it is only Tom who would be able to claim the entire £30,000 relief. Jerry’s relief would be restricted to £10,000. That said, there is scope to consider the income tax liability of the previous year too – so potentially Jerry might yet get more than £10,000.
There are anti-avoidance provisions which exist to prevent an individual from claiming the income tax relief if they are connected to the company. Furthermore, if the shares are sold within three years, some or all of the income tax relief may have to be repaid to HMRC.
In addition to the income tax relief, for every £1 of investment an individual can defer up to £1 of any capital gains which they might realise on other assets. The investment must be made within 12 months before, or 36 months after, the capital gain being realised. Please note that because this only defers the other gain, rather than exempts it, the deferred gain might be re-charged to CGT in the future.
Selling the shares
If income tax relief was originally claimed, then if the individual sells their shares more than three years later, any gain which they might realise will be exempt from CGT. This is a potential CGT saving of up to 20%, compared to shares which are not exempt.
Alternatively, it might be that the shares are sold at a loss. Usually a loss on the sale of shares would be a capital loss. However, with EIS shares, an individual has the choice between using the loss as a capital loss or as an income loss. Given that the maximum rate of income tax is 45%, as compared to 28% for CGT, for some people an income loss will be more valuable.
Any income tax relief retained from the subscription will reduce the size of the loss.
Owning the shares
Shares which qualify as EIS shares will invariably also qualify for business property relief (BPR) – albeit (usually) only once they have been owned for two years. Shares which qualify for 100% BPR will attract no IHT if they are still owned at the time of death.
This is a potential IHT saving of up to 40%, compared to shares which do not qualify.
Recycling EIS investments
As can be seen, once an individual has owned EIS shares for at least three years, their original income tax relief will be secured, and any potential capital gain realised on sale will be exempted.
Consequently, it could be that the individual sells their shares after three years and uses the sale proceeds to subscribe for new EIS shares in a different company. That new subscription could then benefit from its own income tax relief.
If any capital gains were deferred using the first EIS investment, such deferred gains will become chargeable at the point that those first EIS shares are sold. However, it could be that the second EIS investment then allows for further CGT relief to be claimed (ie re-defer the gains).
A new three-year ownership clock would start for the purposes of the original income tax relief, and the CGT sale exemption. However, importantly, a new two-year clock would not start for IHT purposes. Where an individual sells a BPR qualifying asset, and within three years uses the proceeds to acquire a new BPR qualifying asset, the two ownership periods are essentially aggregated together. This avoids the risk of acquiring new EIS shares less than two years before death and missing out on the IHT relief which was previously available.
If you are considering an EIS investment, you may want to seek financial advice first. There is always the risk your original investment goes down in value, rather than up.
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Fund out more about the scheme here – Use the Enterprise Investment Scheme (EIS) to raise money for your company