- Financial planning
- 5 minute read
The Enterprise Investment Scheme (EIS) is a tax relief scheme designed to encourage investment in early-stage companies. Introduced by the UK government in 1994, it has become a well-established tax-efficient investment scheme, raising more than £20 billion for UK start-ups so far. Here, we look at how the Enterprise Investment Scheme works and highlight the tax breaks on offer to investors.
How does the Enterprise Investment Scheme work?
The objective of the Enterprise Investment Scheme is to help smaller UK companies raise capital. Under the EIS, qualifying companies are able to raise up to £5 million per year (up to a maximum of £12 million in a company’s lifetime) to fund business growth and development by issuing new shares and selling these shares to investors.
Investors in the Enterprise Investment Scheme benefit from a range of generous tax breaks. Investors are potentially able to claim EIS tax relief on up to £1 million worth of investments in qualifying companies per person per year. This rises to £2 million in the case of ‘knowledge-intensive’ businesses, such as those in the life sciences sector.
What tax relief does the EIS offer?
The Enterprise Investment Scheme provides a range of attractive tax benefits to investors. These include:
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Income Tax relief: Investors benefit from Income Tax relief of 30% of the sum invested in EIS-qualifying investments, up to a maximum of £1 million (£2 million for knowledge-intensive companies) per year. Income Tax relief of up to a further £1 million can also be carried back to the previous tax year.
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Tax-efficient growth: Investors pay no Capital Gains Tax (CGT) on gains realised on the disposal of EIS investments provided the shares are held for three years.
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Capital Gains Tax deferral: An investor can defer paying Capital Gains Tax (CGT) on other investments by investing the proceeds in qualifying EIS shares. This applies to any chargeable gains arising three calendar years prior to, or one year after, the issue of qualifying EIS shares.
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Inheritance Tax exemption: Shares in EIS-qualifying companies generally qualify for Business Property Relief for IHT purposes after two years. This means that any liability for IHT is eliminated after this holding period.
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Loss relief: If EIS shares are disposed of at a loss, an investor can elect to offset this loss, net of any income tax relief given, against their income in the year the shares are disposed of, or the previous year.
EIS tax relief examples
To illustrate how EIS tax relief works, we provide two examples below.
Example 1:
You invest £20,000 in an EIS-qualifying company and hold the shares for three years. The company does well and your EIS shares double in value. Your top rate of Income Tax is 45%.
Initial investment = £20,000
Income Tax relief = £6,000 (30% of £20,000)
Capital Gains Tax = £0
Total gain = £26,000 (£20,000 profit from the sale of the shares plus £6,000 Income Tax relief)
Example 2
You invest £20,000 in an EIS-qualifying company and after two years, it ceases trading and your investment is worth nothing. Your top rate of Income Tax is 45%.
Initial investment = £20,000
Income Tax relief = £6,000 (30% of £20,000)
At risk capital = £14,000 (£20,000 minus £6,000)
Loss relief on at risk capital @ 45% = £6,300
Actual loss = £7,700 (£20,000 – [£6,000 + £6,300])
Who is eligible for EIS tax relief?
To qualify for EIS tax relief, you need to meet certain requirements:
- You must be a UK taxpayer
- You must not be connected to the EIS-qualifying company (i.e. an employee, partner, or paid director)
- You must invest in brand new EIS-qualifying shares that are not already on the market
- You must hold the EIS-qualifying shares for a minimum of three years. If you sell or gift the shares within the three-year period, you will be subject to relief clawback
- You must make a tax relief claim within five years of the first 31 January following the tax year in which the EIS-qualifying investment was made
Investors can only claim tax relief once the EIS-qualifying company sends through an EIS3 form. Claims can be made when completing your Self-Assessment tax return.
What kind of companies can raise money through the EIS?
The nature of EIS-qualifying companies varies. They operate across a wide range of industries. However, to be eligible to raise money through the EIS, a company needs to meet certain requirements. It must:
- Be permanently established in the UK
- Carry out a qualifying trade
- Not be trading on a recognised stock exchange at the time of share issue
- Not be controlled by another company
- Not control other companies other than qualifying subsidiaries
- Not expect to close after completing a project or series of projects
- Have gross assets of less than £15 million before the shares are issued
- Have less than 250 full-time employees when the shares are issued
What are the risks of the Enterprise Investment Scheme?
Investing in the Enterprise Investment Scheme involves a high degree of risk. EIS-qualifying companies are, by their nature, much higher risk than large, publicly-listed companies. They’re also significantly more illiquid. If you invest in an EIS-qualifying company, there is a significant risk of losing money. Losses may be equal to the whole amount invested.
Given the risks, the EIS is really only suitable for financially-sophisticated investors that are capable of evaluating the merits and risks of EIS-qualifying companies, and that have the financial resources to be able to bear any losses which may arise.
It should also be noted that tax rules and regulations are subject to change and the tax relief available will depend on the investor’s individual circumstances.
Opportunities for high-net-worth investors
For high-net-worth investors, the Enterprise Investment Scheme can offer significant opportunities. Via the scheme, investors can invest in the next generation of British businesses while enjoying some of the most attractive tax breaks available in the UK.
It’s important to realise, however, that the EIS is a higher-risk investment scheme. If you are considering using the scheme to grow your wealth or reduce your tax liabilities, it’s a good idea to speak to a financial adviser first.
Learn more about our investment advice service, or find out how we can help you with the Enterprise Investment Scheme, or any other areas of investment management or tax planning, don’t hesitate to request a call back by clicking the button below.
Capital at risk. Any tax benefits will depend on your personal tax position and rules are subject to change.