Launched in 1994, the Enterprise Investment Scheme (EIS) is a government scheme designed to help certain types of small higher-risk unquoted companies to raise capital. It does so by providing income tax and capital gains tax (CGT) reliefs for investors who subscribe for qualifying new shares in these companies.
Income Tax Relief
Subject to various conditions, investors may obtain income tax relief at 30% on qualifying investments of up to £1 million per annum (a reduction of up to £300,000 of your income tax liability), although please note that the income tax relief is withdrawn if these shares are disposed of within three years. Income tax relief can only be claimed if you have a sufficient income tax liability.
Eligibility for income tax relief is restricted to companies with which you are not connected at any time during a period beginning two years before the issue of shares and ending three years after that date, or three years from the commencement of the trade if later.
Carry Back Relief
There is a “carry back” facility where part or all of the EIS investment can be treated as being purchased in the preceding year.
Should the value of your EIS investment make a loss, it may be possible to apply for Loss Relief. The amount of the loss is restricted by 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 also be set against income in the year, or previous year, in which the EIS investment is disposed of, instead of being set off against any capital gains. By helping to minimise the impact of the loss, this relief may ultimately improve the risk/return profile of your investment.
Capital Gains Tax (CGT) Deferral
CGT is normally charged when certain capital (or ‘chargeable’) assets are sold at a profit. However, deferral relief means it is possible to defer a CGT payment on gains arising on disposals of any assets where these gains are reinvested in new shares in an EIS company. The chargeable CGT is deferred for the life of the investment. You can defer gains made in the 36 months prior to your investment or 12 months after.
Inheritance Tax (IHT) Exemption
After two years an EIS investment qualifies for Business Relief (BR) and therefore can be free from Inheritance Tax (IHT).
To qualify under the EIS, both the investor and the company must meet a number of conditions. The investor, or someone who is connected with them, must not be an employee or director before their investment. Appointment as a directly subsequently is possible. In addition, investors must not hold more than 30% of any of the following (in neither company itself or of a 51% subsidiary of the company):
- voting rights
- assets on a winding up
To qualify for the EIS, the gross value of the company must not exceed £16 million after the investment, and there are restrictions to ensure that the EIS capital is at risk and for genuine growth. The company must also be unquoted when the shares are issued, have fewer than 250 full-time employees (or the equivalent) and have raised less than £5 million under any of the venture capital schemes in the 12 months ending with the date of the relevant investment.
Hayley invests £100,000 in shares in Company A. In this case, income tax relief will be worth £30,000 (30% of £100,000). The net cost of Hayley’s EIS investment is therefore £70,000 (£100,000 – £30,000). Hayley also reclaims CGT of £28,000 on a previous £100,000 gain 2 years ago taxed at 28%. Note: the gain is only deferred until there is a chargeable event, i.e. disposal of shares.
In the second column, the company performs well and after three years, another company has made an offer to acquire all shares in Company A. Hayley will receive £150,000. Her gain of £50,000 is exempt from CGT as the shares have been held for at least three years. The £28,000 CGT previously deferred comes back into tax again at current rates of CGT, unless the £100,000 is reinvested again into EIS shares.
In the third column, the company performs badly and is written off after three years. Hayley will receive £61,500 or 61.5% of her original investment. The original £30,000 income tax relief and £31,500 in EIS loss relief on her net cost of the investment of £70,000 (£100,000 – £30,000 income tax relief) at 45% marginal income tax rate, assuming she is an additional rate taxpayer. So, all in all, a net loss of £38,500 or 38.5% of her original investment of £100,000.