The Enterprise Investment Scheme or EIS as it is commonly known is a tax incentive in the UK introduced to encourage investment into early stage and SME companies. There are a number of tax breaks available to investors, and the benefits to the companies are well documented.
Here we will discuss the £1.5bn+ EIS marketplace, how the tax relief works, when you can expect to receive the tax relief and the different investment options available to you.
These tax breaks enable businesses to secure capital which otherwise may not be available, therefore it is an extremely important tax incentive which must continue if the UK is to continue to grow tech, ideas and general entrepreneurialism.
Tax Reliefs Available Under The Enterprise Investment Scheme
There are a number of tax reliefs available under the Enterprise Investment Scheme, these are broadly broken down into the following:
Income Tax Relief for Enterprise Investment Scheme – The Details
Investors into qualifying Enterprise Investment Scheme companies should receive income tax relief at 30% of their investment amount. Each investor has an annual allowance of £1,000,000 per annum, or £2,000,000 per annum for knowledge intensive companies from 2018.
There are various conditions that both the EIS qualifying company and the investor are required to meet, including:
Eligibility for income tax relief is restricted to companies with which you are not ‘connected’. This is considered in ‘How to qualify for income tax relief’ below.
Capital Gains Tax Exemption
EIS shares are exempt from capital gains tax, unless the income tax relief is withdrawn. This means that if an investor purchases shares for a £1, then sells them at £10, the gains will not be taxable.
Furthermore, losses on the disposal of EIS shares are allowable. The amount of the capital loss is limited to the amount of the EIS income tax relief still attributable to the shares disposed of.
A capital loss arising on the disposal of EIS shares can be set against income.
EIS Qualifying business activities
HMRC have established a clearly defined list of qualifying trades, these include most businesses which have a genuine commercial activity, however there are some exclusions, these include:
EIS Qualifying Companies
There are a range of qualifying criteria that compaies must meet to qualify to become EIS qualifying, these include:
Time period in which the money is invested
The time limit for the employment of money invested is to two years from the issue of the shares or, if later, two years from the commencement of the qualifying activity.
Changes to the rules for qualifying companies
Over recent years, the government has made significant changes to the qualifying criteria for EIS companies, therefore it is imperative that each company receive advance assurance from HMRC in advance of investment being made.
How to qualify for income tax relief
Most EIS investors will automatically receive Income Tax Relief for their investment into EIS qualifying companies. Where some challenges arise if there is an existing relationship, this is defined by HMRC as you are not ‘connected’ at any time during a period beginning two years before the issue of the shares and ending three years after that date, or three years from the commencement of the trade if later.
HMRC’s definition of connected is in two key ways:
How to qualify for CGT deferral relief
It is possible to defer a chargeable gain into an EIS qualifying company, in addition you can defer revived gains arising to you in respect of earlier EIS, Venture Capital Trust (VCT) or CGT reinvestment relief investments.
It is important to note that there are some restrictions on investments against which gains can be deferred. These are designed to prevent relief being obtained in circumstances where there is a disposal and acquisition of shares in the same company
What’s the difference between an EIS Fund and An EIS Company?
An EIS Fund is normally managed by an FCA regulated EIS Fund manager, who’s job is to identify and invest capital on behalf of its clients. The Information Memorandum (IM) for the fund will normally explain the EIS Fund Managers mandate and provide details regarding the types of companies that the Fund will seek to invest into.
An EIS Company is a single company which will normally have received HMRC Advance Assurance in advance of investment being concluded.
Types of EIS Funds
There are two broad types of EIS Funds: approved, and unapproved.
To be classed as HMRC approved the EIS prospectus must be reviewed and furthermore approved by HMRC.
If the approved fund invests at least 90 per cent of its assets in EIS approved investments within the 12 months following fund closing, investors in the fund will be treated as having made the EIS investments as at the date the fund closes, this provides a slight advantage over the unapproved route where the underlying investments will not be considered to have concluded until the underlying investments are made by the fund manager, which can take up to 12-18 months.
The benefit for an investor or advisor is that this defines which tax year that the investment is made, and therefore when income tax relief can be obtained.
There are several other requirements for an approved fund, with the fund being required to invest at least 90 per cent of the capital being invested within 12 months and the fund must also invest in at least four underlying companies and must not make any investments until it is officially closed.
Each of the Companies that an EIS Fund will invest into will need to be EIS qualifying.
Unapproved EIS Funds
The majority of fund managers tend to use the unapproved route as it provides more flexibility and will allow the fund manager slightly more time to make the right investments, as opposed to being under pressure to deploy funds quickly so that the tax reliefs can be granted quickly. For an unapproved EIS Fund the Fund manager has up to 2 years to invest funds, albeit the tax relief is only granted at the point that the underlaying investment is made.
Types of EIS Companies
By their very nature, EIS Companies tend to be relatively early stage, and often will have limited trading history. Historically, investors were able to invest into asset backed investment opportunities such as pubs and other businesses which had underlying assets.
However, in 2018 the HMRC changed the legislation which disallowed investment into these types of companies and intentionally focused investment into businesses which had “real risk”, and accordingly high growth potential.
This has resulted in a drop in the level of investment which is being made as lots of fund managers built up their books of business by effectively recycling clients money, giving lower risk investment strategies with accordingly lower returns.
Following the Patient Capital Review HM Treasury and HMRC amended the legislation for EIS to encourage investment to be made under what they call the “spirit of the legislation”, i.e. into companies which really need the money and are high risk, and accordingly high reward. This has resulted in a new landscape, and one where most Wealth Managers and Advisors will normally advise their clients to build a portfolio of investments as opposed to investing all of ones capital into a single company.
EIS Investment Sectors
Key sectors in the EIS marketplace at the time of writing include:
As described above there are a number of sector which are non-qualifying for EIS purposes, these include property development, financial services etc.
