Thinking of investing in something interesting? Have a great fledgling business but struggling to raise finance? You might have heard of Enterprise Investment Scheme (“EIS”) but do you know how it could potentially be of use to you?
What is the Enterprise Investment Scheme?
EIS was designed so that your company can raise money to help grow your business. It does this by offering tax reliefs to individual investors who buy new shares in your company
The scheme was launched way back in 1994 and the rules have changed over the years – usually to the benefit of investors as HMRC has recognised how popular the scheme has become. Knowledge Intensive Companies (KICs) were introduced from 6 April 2018 and attract higher rates of tax relief.
Is there a minimum investment for EIS?
There is no minimum investment amount to be invested so this is available to small investors as well as those looking to invest substantial sums.
There are great tax breaks available to encourage investment into small and medium-sized companies. The government is keen for inward investment into these firms, especially ones that are innovative and would find raising capital via traditional routes such as a listing on a recognised stock exchange, difficult, or prohibitively expensive.
What are the rules for qualifying for EIS?
As you’d expect, that are rules about what sort of companies qualify for EIS but broadly speaking, they have to be unquoted, trading companies not involved in financial trading, accounting, law or property development. They have to be UK based, in good financial health and not be under the control of another company. The assets of the company mustn’t exceed £15m before the EIS investment and £16m afterward.
Also, the company cannot employ more than 250 people (500 for KICs). The EIS share issue must take place within 7 years of the first commercial sale made by the company.
This is to target the relief towards young, growing companies. The investor cannot be ‘connected’ to the company – i.e. an employee or owning >30% of the share capital. An employee includes a director, however, there are some special circumstances which enable a director to claim this relief.
Finally, there must be no pre-arranged exits – i.e. the company must not guarantee the investor any sort of return on his investment. Only if the investor is taking a bona fide commercial risk, will HMRC offer any form of tax relief? There must be a ‘significant risk to capital’ so the company cannot have the aim of capital preservation – it must be aiming to grow and develop.
There are 5 different tax reliefs available to personal investors and these are explored below. If you are a company wanting to attract investment, your company won’t qualify for these reliefs, but they are worth understanding so you know what makes your company shares more attractive than standard shares.
Income tax relief 1
A taxpayer will receive tax relief when they subscribe for shares in a qualifying EIS company. This means that the company is issuing new shares to the investor. Tax relief is restricted to the lower of the amount subscribed or £1m. The relief is given as a tax reducer at a flat rate of 30%, in 2018/19 the maximum tax reducer in an EIS company is £1m x 30% = £300,000.
If shares are subscribed for in KICs, the maximum overall amount eligible for EIS relief is £2m, of which no more than £1m can be invested in companies that aren’t knowledge intensive. This gives a maximum tax reducer of £600,000.
EIS subscriptions can be carried back and used against the tax liability of the preceding year which can be useful when tax planning. There are rules concerning the disposal of the shares acquired and HMRC will claw back some/all of the relief if the shares are sold within 3 years of issue.
Income tax relief 2
There is a second relief available to do with income tax and this is unusual. If a loss is made when shares are sold, then usually this can only be offset against capital gains. If the loss arose on the disposal of EIS shares, then the loss can be set against the current year’s income and/or the preceding year. This is the only time that a taxpayer can set a capital loss against income under current UK tax law.
Capital Gains Tax (CGT)
Is a deferral relief – if the gain on an asset sale is reinvested into qualifying EIS shares, the CGT on an asset sale is still payable, but not until the EIS shares are sold.
If an individual sells an asset (any chargeable asset) and reinvests the sale proceeds in acquiring qualifying EIS shares, they may claim EIS reinvestment relief. Like gift relief, EIS reinvestment relief allows the taxpayer to defer the capital gain to a later time. There is no ceiling to the amount of the gain that can be deferred – the £1,000,000 subscription limit only applies for income tax purposes.
EIS reinvestment relief is more flexible than gift relief, in that it allows the gain on an asset to be deferred, as long as the proceeds are reinvested in qualifying EIS shares. The capital gain arising on the sale of the original asset is effectively “frozen” until the EIS shares are disposed of. There are time limits relating to this relief, but it can be a useful planning tool to ensure gains are taxed in favourable years.
Capital Gains Tax – exemption relief
Where EIS and SEIS shares are sold at a gain, that capital gain is sometimes exempt from CGT.
The gain is exempt from CGT if two conditions are satisfied.
1. The shares must be sold outside the “relevant period”, which is three years after the issue of the shares.
2. Secondly, the investor must have obtained income tax relief on the subscription. To obtain income tax relief on the subscription, the investor must not have been “connected” with the company. Therefore, if the investor is connected with the company – e.g. he is an employee or owns more than 30% of the shares – he cannot obtain income tax relief on the subscription, so the gains on the shares will not be exempt from CGT.
Where EIS and SEIS shares are sold at a loss – which is very possible – the shares are meant to be high risk to qualify for the reliefs, the loss is always an allowable loss regardless of when the shares were sold. However, in order to calculate the amount of the allowable loss, any income tax relief obtained on the subscription reduces the base cost for capital gains tax purposes. Essentially, any income tax relief obtained by the investor will reduce the capital loss that he or she may claim.
Inheritance Tax (IHT)
This is unlikely to be a primary reason for investing in EIS shares, but is still useful to know and reduces potential IHT payable on death. The rate is up to 100% of the value of the EIS shares held at the time of death (or other IHT chargeable event). The shares need to have been held for a minimum of 2 years and the relief must be applied for by the executors/taxpayer depending on when the charge arises.
There is no maximum financial limit, unlike income tax relief. The 2-year qualifying period starts when the money is used to purchase the shares, not for example, when the money is transferred to an EIS investment manager. There is often a delay (which can be months) between the funds being paid by the investor and actually being invested. The later of the two dates is the important one to use.
It should be noted that the inherent riskiness of investing in new, growing businesses shouldn’t be overlooked. The tax advantages are substantial but shouldn’t be the main reason for investment.
Contact us if you want to know more about EIS or need business coaching services.