The Enterprise Investment Scheme (EIS) was launched by the UK government in 1994 to encourage private individuals to invest in British start-ups by offering them a roster of generous tax breaks.
The structure of EIS recognises the higher risk nature of an investment in a young, growing private company compared to buying shares in a stock market listed company that can be sold at the drop of a hat. The range of tax relief incentives EIS investments are supported by reduce that risk profile considerably as a large chunk of capital invested is clawed back at the point the investment is made, as well as further tax relief on future profits or losses.
And for companies that qualify for the Enterprise Investment Scheme, it’s a great way to raise equity-based venture capital to fund their growth.
Tax Relief For EIS Investors
Income Tax Relief On Initial Investment In EIS-Qualifying Companies
EIS investors are eligible for 30% income tax relief. There is no minimum investment level at which this relief is activated and the maximum EIS investment that it can be applied to is £1 million in any tax year. That means, for EIS investors who pay sufficient income tax, up to £300,000 is available in income tax relief.
EIS allowances, like most other tax relief allowances offered by the UK government, are applied to each individual rather than household. A married couple can therefore benefit on income tax relief worth up to £600,000 on EIS investments worth up to £2 million per tax year.
EIS investors should not have any connection to the company being invested in to qualify for income tax relief.
EIS Income Tax Relief ‘Carry Back’
EIS investors can additionally benefit from a ‘carry back’ mechanism, which means the entire or part cost of acquiring EIS-qualifying shares can be treated as though they were acquired in the preceding tax year, with income tax relief applying to that year. Making use of the carry back facility is subject to the investor not exceeding the income tax relief limits for each year.
Capital Gains Tax Exemption On EIS Investments
If EIS investors have held their shares for at least three years, and claimed income tax relief when the investment was made, no Capital Gains Tax (CGT) will be chargeable on any eventual profit realised through selling the shares.
There is no maximum period for which EIS shares can be held to still qualify for CGT exemption on their sale.
Capital Gains Tax Deferral Relief On EIS Investments
EIS investors can also defer any Capital Gains Tax due on the sale of other assets if they choose to invest profits in EIS qualifying company shares. The EIS investment should be made either up to one year before the gain was realised or up to three years after.
In the case of CGT deferral relief, there are no restrictions around personal connection to the EIS-qualifying company.
Loss Relief On EIS Investments
Investors in EIS-qualifying companies are also able to access income tax relief if their investment results in an eventual loss. The total value of the loss, minus initial income tax relief at the point the investment was made, can be deducted from income tax due on the tax year during which the loss was realised. Losses can alternatively be set against income during the previous tax year instead of against capital gains made elsewhere.
EIS Investments Are Exempt From Inheritance Tax
A final major tax advantage of EIS investments is that they are exempt of Inheritance Tax IHT) under Business Property Relief rules. This means EIS investments can be a valuable part of any IHT mitigation planning.
A full, detailed, explanation of the tax relief available to EIS investors can be found on the HMRC website.
Examples Of How EIS Tax Relief Works
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Scenario 4:
The company does well and the value of EIS shares held for over 3 years increases by 400%
- Initial Investment – £10,000
- Income Tax relief – £3,000
- EIS shares sold for – £40,000
- Capital Gains Tax = £0
- Investor’s gain = £33,000 (£30,000 profit on the sale of shares + £3,000 income tax relief)
The company does well and the value of EIS shares held for over 3 years doubles Initial Investment
- £10,000 Income Tax relief
- £3,000 EIS shares sold for
- £20,000 Capital Gains Tax
- £0 Investor’s gain = £13,000 (£10,000 profit on the sale of shares + £3,000 income tax relief)
The company’s value stays the same and EIS shares are sold at the same value as acquired Initial Investment
- £10,000 Income Tax relief
- £3000 Shares sold at
- £10,000 EIS shares sold for
- £10,000 Investor gain
- £3,000 (from the income tax relief)
The company fails and EIS shares are worth nothing Initial Investment
- £10,000 Income Tax relief
- £3,000 Capital at Risk
- £7,000 Loss relief capital at risk 45% ((additional rate tax payer)
- £3,150 Final Loss on Initial Investment
- £3,850 (£10,000 – [£3,000 + £3,150])
Conditions Under Which EIS Tax Relief Is Restricted
There are a number of circumstances under which EIS investors may not be eligible for all tax relief facilities normally available.
EIS Investor Has A Personal Connection To The Company Being Invested In
Any EIS investors with a personal connection to the qualifying company being invested in, defined as pre-existing financial interest or employment, is not eligible for income tax relief.
Financial interest is defined as the investor already owning at least 30% of either the company’s equity or voting rights up to 2 years before and 3 years after the EIS-qualifying share issue. So, for example, if an originally EIS investor with a smaller minority stake in the company were to increase that stake beyond the 30% threshold within 3 years of the original investment, income tax relief taken advantage of would be repayable.
Partners, directors, associates (business partners, trustees and relatives) and employees all count as having a personal connection to an EIS-qualifying company and may not benefit from income tax relief. Angel investors who hold a non-remunerated director role are excepted.
Again, personal connection to the business is counted over 2 years before and 3 years after the issue of EIS-qualifying shares.
How To Claim Tax Relief On EIS Investments
To claim tax relief on an EIS investment, the qualifying company must have already filed an EIS3 form, documenting your investment. The investor themselves must then claim applicable tax relief through a Self-Assessment tax return for the year shares were issued. Future claims such as loss relief or CGT exemption or deferral will also be made through a Self-Assessment tax return for the relevant year.
Claims can be made within five years of the investment, counted from the first January 31st to fall after the tax year the investment was made. So, If the investment was made on February 1st, the five-year period will not commence until January 31st the following year.
Why Invest Through EIS?
The Enterprise Investment Scheme is a risk-adjusted way to invest in high risk-high reward private companies. The tax reliefs EIS investors can take advantage of significantly reduces the percentage of the capital initially invested exposed to risk without the benefit on the downside compromising the upside benefit if the company, and investment, increases in value.
In fact, the upside is also boosted by the fact that any gains are exempt of Capital Gains Tax, and inheritance tax, as long as shares have been held for at least three years.
What Kind Of Investor Are EIS Investments Suitable For?
Any kind of investment in a young, private company is inherently high risk. Which is why the government offers generous tax relief options to encourage private capital into growing British companies.
But the risk profile of such investments mean EIS is not suited to standard retail investors. EIS investors should be either self-assessed or independently qualifying as sophisticated or high net worth investors.