Dive into the world of PAYE investigations. Uncover the facts, implications, and insights in this informative blog
There are several benefits for the EIS, or Enterprise Investment Scheme, to make this an interesting and tax-efficient way for investors to invest.
The Enterprise Investment Scheme was created in 1994 by the UK government to help encourage investors to invest in unquoted, small trading companies.
The incentive for doing so was for the investor to enjoy tax benefits including a 30% tax reduction on any investment worth up to £1 million – per tax year.
Here, we take a closer look at what the Enterprise Investment Scheme is, and how investors can use it as part of their investment portfolio.
How Does An EIS Work?
In addition to investing in EIS qualifying firms, investors can also do so through an EIS fund.
This will see the investor using the platform to invest in a range of qualifying companies.
There's no limit on how many EIS investments an investor can make in a tax year, unlike other forms of investments with a tax advantage.
However, EIS tax reliefs are only available for any given tax year on investments worth up to £1 million. In a ‘knowledge-intensive’ company this limit is now £2 million.
Joint investments are not allowed under the scheme and all investments must be in the name of one person.
Is EIS Investment For Me?
There are pros and cons to the Enterprise Investment Scheme and investments are suitable for most UK taxpayers, but the following rules will apply:
- You will need an income tax liability in the previous or current tax year;
- You can defer Capital Gains tax;
- You will benefit from Inheritance Tax (IHT) relief.
How Does An EIS Investor Claim Their Tax Relief?
Having stated that the Enterprise Investment Scheme brings tax benefits, how do you go about claiming your tax relief?
Essentially, your tax advantage can be claimed after the qualifying shares have been bought and the EIS3 certificate has been received that relates to those shares.
You can then:
- Apply the tax relief to your income tax return in the tax year when you purchased the shares
- Or you can 'carry back' against your income tax which was paid in the previous tax year.
Enterprise Investment Scheme Benefits
It's worth taking a closer look at some of the benefits that come with the Enterprise Investment Scheme.
Income Tax Relief
An investor will enjoy a reduction in their income tax liability of 30% on their investment, up to a £1 million maximum – or £2 million for knowledge-intensive companies.
The tax relief claimed cannot exceed an amount that will reduce the EIS investor's income tax liability to zero.
Capital Gains Tax Deferral
The Enterprise Investment Scheme offers a facility to defer the paying of Capital Gains Tax (CGT) on part or all of a chargeable gain from the proceeds from qualifying EIS shares. This includes:
- CGT deferral will apply to chargeable gains arising for three calendar years before, and one year after, the issuing of any qualifying EIS shares
- The gains can be deferred until a chargeable event, for example, the EIS shares are disposed of, or there's a breach of the EIS rules
- There is no CGT liability on those gains realised when EIS investments are disposed of if income tax relief has been claimed.
This last point is important because there is Share Loss Relief available if those Enterprise Investment Scheme shares have been disposed of but at a loss.
You can then select whether the loss amount, net of the previously given income tax relief, can be set against your income tax bill in the year for which the shares have been disposed of, or for the preceding year - instead of that amount being set off against any capital gains liabilities.
EIS And Inheritance Tax Relief
Enterprise Investment Scheme investments that qualify for Business Property relief are exempt from Inheritance Tax after two years - but you must retain ownership of the shares on death.
Plus, the income tax relief you may have claimed will not be clawed back and any deferred capital gains will be extinguished permanently.
If your EIS shares are transferred to a beneficiary and then sold subsequently, they will be subject to Capital Gains Tax – with their value at the point of transfer being the acquisition cost for the calculating of the CGT gain.
The Risks Of An EIS Explained
Investing in an Enterprise Investment Scheme, just like any investment, will involve risk.
It's important that as an investor you understand what these risks are before deciding that the EIS will be the right investment vehicle for meeting your needs.
This means that you will need to be prepared for the value of your EIS investment to go down - or go up - and your capital may be at risk.
Not only should you discuss any potential EIS investment with a suitably qualified financial advisor but be aware that EIS investments are not regulated by the Financial Conduct Authority (FCA).
As such, your investment will not be protected by the Financial Services Compensation Scheme (FSCS).
However, an EIS fund must be run by an FCA-approved fund manager. An individual company does not need to be run by an FCA-approved fund manager.
Other considerations about the risks of investing in an EIS include:
- The tax rules and regulations covering EIS may change, as they do with other investment types.
- The tax reliefs available depend on an individual investor's circumstances.
Income Tax Relief Rules For EIS
The most important issue to qualify for income tax relief with the Enterprise Investment Scheme, is that the investor cannot be connected with the firm. This means they cannot be employed by or have a significant financial interest in the investee company.
These conditions apply for a period of two years before the shares are issued, and up to three years after an investment has been made.
You will be recognised by HMRC as being connected if you:
- Are a paid company employee
- Are a director of that company, although EIS relief is possible under certain conditions
- A partner of the business
- Have a 30% or greater interest in the firm or any of its subsidiaries.
The only exception to these rules is if you are an unpaid company director as you will be able to claim the relief. If you want to be a paid director and still get EIS relief then it is possible under a strict ordering of the directorship, first payroll processing and when you invest.