Financial Adviser Hastings

Enterprise Investment Schemes (EIS)

As a result of being a higher rate taxpayer with a large annual income, you may have a large annual tax bill which you are keen to reduce. There are various options available to you – see diagram below.

Although the finer details of the investments which qualify have changed over time, one of the government initiatives introduced to attract capital for smaller, early stage companies has now been running since 1994 and is well established in the tax efficient investment space; The Enterprise Investment Scheme, or more simply, EIS.

To compensate for the higher level of risk involved when investing in smaller unquoted companies, the government provides attractive tax reliefs for investors. However, growth in this area of investment is being driven not only by these tax reliefs, but also by the strong evidence that EIS’ are, in many cases, delivering very attractive returns, and fit well into a diversified growth portfolio. The reductions to the pensions annual and lifetime allowances and the demand for a tax enhanced alternative is also leading to increased interest amongst investors.

EIS’ provide finance for smaller companies to help them develop and grow, and this area of investment is increasingly attractive. This is a vital yet underfunded sector, which contributes significantly to the UK economy, providing high numbers of jobs as well as a large contribution to GDP. According to a 2016 industry report (AiR), total employment in Small and Medium Sized Enterprises was 15.6 million in 2015. Current ONS figures (Jan 2017) state there are 31.80 million people in work in the UK, whether full-time or part, therefore SMEs employ almost half of all of those in employment. The government recognises the benefits smaller businesses bring to the UK economy and offers a range of tax benefits to reward you for investing in small companies through an EIS.

Providing the underlying investments made by the EIS are held for at least three years, there are five
separate tax advantages for which you may be eligible:

1) Income tax relief: Investors benefit from 30% tax relief. The maximum investment per tax year is £1,000,000, giving a maximum tax reduction of £300,000, providing you have sufficient Income Tax liability to cover it. As an example, an investment of £50,000 would enable you to reclaim £15,000 back in tax.

2) Capital gains exemption: Gains within the portfolio are not subject to capital gains tax.

3) Capital gains tax (CGT) deferral: Taxable capital gains can be invested into EIS shares and the CGT will be deferred for the life of the investment. The gain can be made in the 36 months preceding EIS investment or 12 months following it. When an investor comes to sell their EIS shares, they may be able to make use of their annual CGT allowance to reduce their liability. However, any CGT still due would be payable at the then current rate, which could be higher or lower than the rate when the liability was deferred. On exit of the EIS, you can place the gain back into another EIS to continue to defer it.

It is also worth noting that any deferred CGT liability is eliminated on death – so if an individual still holds the EIS shares when they die the tax liability on the gain they deferred dies with them.

4) Loss relief: In addition to CGT exemption, EIS holdings are also eligible for loss relief on losses in excess of the original income tax relief granted. This is unusual, as with most investments if falls in value are viewed as an ‘allowable loss’ for investors, then any increase in value is liable to CGT. Some specific investment types (such as ISAs or VCTs) are free from CGT when they go up in value, but there is no tax relief if they go down in value. Losses can be set against either income or capital gains when calculating the investor’s overall tax liability.

5) 100% Inheritance tax relief after two years: Provided funds remain deployed in qualifying trades within the EIS companies, investments should be eligible for Business Relief. Investments which qualify for Business Relief are excluded from inheritance tax calculations on a persons estate, if held for a minimum of two years and at time of death. Once assets have qualified for Business Property Relief, they can be reinvested in other qualifying assets to remain excluded for inheritance tax purposes.

Managing Risk

Investment into smaller companies is classified as high risk, however there are many different types of investment that qualify for investment in EIS, some are asset-backed to provide greater security while others are in growth companies for example focussing on technology or Oxbridge spin-off medical treatment companies; some invest across the whole spectrum of industries. In this way there is a risk / return profile within the EIS marketplace, and of course, a diverse portfolio can be built using several different products. At McPhersons Financial Solutions, our thorough due diligence process in selecting the companies we recommend ensures that there are stringent controls in place to minimise risk.

Why use EIS?

This investment may be suitable for investors 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 pension savings

As with any investment, the value can fall as well as rise and you may not get back what you put in.

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