There are several benefits that make the EIS an interesting and tax-efficient way to invest. Whether you are a founder looking to raise capital or a taxpayer looking to optimise your portfolio, this guide covers everything you need to know.

What is EIS? (EIS Explained)

The Enterprise Investment Scheme was created in 1994 by the UK government (succeeding the popular Business Expansion Scheme) to encourage investment in unquoted, small trading companies.

The incentive for doing so is to offer investors substantial tax benefits in exchange for investing in riskier, early-stage ventures. Companies seeking EIS investment are typically more developed than those looking for funding using the Seed Enterprise Investment Scheme (SEIS), and the investment limits and tax reliefs available reflect this.

In a major boost of confidence for the scheme, the UK government recently extended the EIS "sunset clause," ensuring the scheme will remain active and available until at least 2035.

EIS Benefits: Tax Reliefs for the Investor

For investors, the main benefits of the EIS scheme are designed to offset the capital risk associated with unquoted companies. The primary tax reliefs available include:

• EIS Income Tax Relief: Investors enjoy a reduction in their income tax liability of 30% on their investment. This is known as the EIS 30% tax relief. The tax relief claimed cannot exceed an amount that will reduce the investor's income tax liability to zero.
• EIS 1 Million Limit: Relief is available on investments up to £1 million per tax year. However, this limit is doubled to £2 million if at least £1 million is invested in "knowledge-intensive" companies (KICs).
• EIS Carry Back: You can "carry back" your investment to the preceding tax year, applying the relief against your previous year's income tax bill.
• Capital Gains Tax (CGT) Exemption: There is zero CGT on the disposal of qualifying shares, provided you have held them for a minimum of three years.
• CGT Deferral Relief: You can defer the paying of CGT on a chargeable gain from the sale of any asset if you reinvest that gain into EIS shares. This deferral applies to gains arising three years before, or one year after, the EIS share issue. The gain is frozen until a chargeable event occurs (such as selling the EIS shares).
• EIS Loss Relief: If the EIS company fails or shares are disposed of at a loss, you can claim loss relief against your income tax bill or CGT bill. For an additional rate that could be 20%, 40% or 45% in England, Wales and Northern Ireland but other rates in Scotland. This means an actual loss of just £3,850 on a £10,000 investment at the 45% relief rate.
• Inheritance Tax (IHT) Relief: Investments that qualify for Business Property Relief are exempt from Inheritance Tax after two years, provided you retain ownership of the shares on death.

EIS Eligibility: Does My Company Qualify for EIS?

For its investors to be able to claim and keep their tax reliefs, the issuing company has to meet a strict set of EIS company requirements. If the company ceases to meet one or more of these conditions, investors may have their tax relief withdrawn.

The main EIS qualifying criteria are as follows:

• EIS Investment Limits: A company can raise a maximum of £5 million in any 12-month period, with a maximum of £12 million over the company’s lifetime (increased to £20 million for knowledge-intensive companies).
• The Age Rule: The company must receive the investment within 7 years of making its first commercial sale (or 10 years for knowledge-intensive companies).
• EIS Employee Limit: The investee company must have fewer than 250 full-time employees (or part-time equivalents) at the time shares are issued.
• Gross Assets Test: The company’s gross assets must be less than £15 million before any shares are issued and not more than £16 million immediately afterwards.
• The 3-Year Trading Rule: The company must continue trading for at least 3 years from the time the EIS shares were issued. If the company is sold to a third party within this period, HMRC can withdraw the tax relief.
• Spending Rules: The money raised must be spent within 2 years of the investment or the date the business started trading. It must be used to grow or develop the business and cannot be used to buy another business.
• Unquoted Status: The company cannot be trading on a recognised stock exchange and must not be controlled by another company.

EIS Qualifying Trade & Excluded Activities

To qualify, a company must carry out a genuine, commercial trade with a view to the realisation of profit.

However, you must take care to avoid EIS excluded activities. A trade does not qualify if it consists wholly, or substantially (more than 20% of the company’s total activities), of the following:

• Dealing in land, commodities, or financial instruments
• Property development
• Providing legal or accountancy services
• Financial activities (banking, insurance, debt-factoring)
• Operating or managing hotels or nursing/care homes
• Farming and market gardening
• Leasing or letting of assets on hire
• Coal and steel production
• Generation of electricity, heat, gas, or fuel

Investor Eligibility: Connection Rules

To qualify for EIS income tax relief, the investor cannot be "connected" with the investee company. These connection conditions apply for two years prior to any share issue and up to three years after.

You will be recognised by HMRC as being connected if you:

• Are a paid company employee.
• Are a partner of the business.
• Have a 30% or greater interest in the firm or any of its subsidiaries.

The only exception is for unpaid company directors, who are able to claim the relief. If you want to be a paid director and still get EIS relief, this is possible, but it requires a strict ordering of the directorship appointment, payroll processing, and the investment timeline.

How Does EIS Work? (The Process)

Raising finance is not just a matter of meeting eligibility criteria; you must also attract investors. The best way to do this is to secure "Advance Assurance" from HMRC before issuing shares, proving your company qualifies.

Once you have issued shares, here is how to claim EIS tax relief as an investor:

1. Apply for Advance Assurance (highly recommended)
2. Receive the funds and issue shares
3. Spend the Funds Correctly (The 2-Year Rule for EIS)
4. Receive Your Certificates: After the investment is made, the company will apply to HMRC. Once approved, the company will issue you an EIS2 Certificate and EIS3 claim form (for direct investments) or an EIS5 form (if you invested through an approved EIS fund). This contains your unique reference number.
5. Keep A Record Of Your Information: Keep a copy of the claim submission, note the name of the company, the amount claimed, the issue date of the shares, which years claimed in, and the HMRC office reference on the certificate.
6. Claim EIS Relief on Your Tax Return: * Online: On your self-assessment, answer "Yes" to claiming other tax reliefs in Section 3, and enter the EIS details in Section 4.
   • Paper: Use the additional information sheet (SA101) and use Box 2 to give details of your EIS investments.
   • HMRC manual adjustment: You can also complete pages 3 and 4 of the EIS3 form and send it directly to your HMRC tax office to adjust your tax code if you do not have a tax number to file online. However, HMRC response times to post can be up to six months so it is sometimes easier to register for a tax number and file online, and this can be used for future investments as well.

The Risks to Capital

Investing in smaller, unquoted companies involves significant risk, and investors should be very careful not to invest any money they are unprepared to lose.

Investments are highly illiquid, meaning they must be held for at least three years, and there is no guaranteed exit strategy. Furthermore, while an EIS fund must be run by an FCA-approved fund manager, individual EIS companies are not regulated by the Financial Conduct Authority (FCA), and your capital is not protected by the Financial Services Compensation Scheme (FSCS).

At Key Business Consultants, we are highly experienced in ensuring that EIS applications run smoothly and that compliant structures are in place. If you are looking to raise money using the EIS, or if you need expert advice on claiming relief, please get in touch with our team today.