Dive into the world of PAYE investigations. Uncover the facts, implications, and insights in this informative blog
One of the many benefits of the Enterprise Investment Scheme (EIS) is the availability of loss relief in the event that a loss is realised on an investment.
This loss relief allows an investor to offset losses made on a qualifying investment against their Income Tax instead of against or Capital Gains Tax (CGT) bill. Since most people have taxable income but not so many people have taxable gains then this is quite a valuable mechanism.
To benefit from loss relief the value of the EIS investment at the time of sale must have fallen below the effective cost. The effective cost is calculated by taking the investment amount and taking away the amount of Income Tax relief claimed.
For example, if £50,000 was invested into a qualifying EIS and Income Tax relief of £15,000 (30% of the amount you invested) had been claimed then the effective cost of the investment would be £35,000.
The level of loss relief can depend on whether a claim for loss relief is made against Income Tax or CGT. Offsetting the loss against Income Tax will usually provide higher relief especially for taxpayers in the higher rate (40%) or additional rate (45%) tax bands.
CGT relief will usually be given at 20% and is applied by reducing capital gains by the amount of the loss thereby reducing the amount of CGT due.
Any investor claiming EIS loss relief will need to carefully consider their position to ensure they make the optimum use of the loss. However, the situations when it is recommended to make a claim against CGT are generally more limited. The use of loss relief will not eliminate the full cost of an investment but can certainly help mitigate a significant proportion of any loss.
Income Tax relief
Income Tax relief allows an investor to offset the qualifying loss against their Income Tax bill in the tax year that the loss occurred or the previous tax year. Carrying back the loss could give a result in more tax relief if the taxpayer’s marginal rate of Income Tax was higher in the previous tax year.
The claim for loss relief can be extended against both tax years if the loss is large enough. If a taxpayer claims for both tax years then the claim should show which year is to take priority.
The amount of loss relief available is calculated using the effective cost of the investment multiplied by the taxpayer’s marginal Income Tax rate. The Income Tax relief is given by deducting the allowable loss from total income from all sources before any deduction of personal Income Tax allowances.
If the taxpayer is still unable to utilise all the loss, then the remaining amount can be set against chargeable gains in the usual way. You cannot restrict the amount of loss claimed in the first year to preserve the personal allowance.
CGT disposal relief
An investor can claim CGT disposal relief on EIS shares. As we mentioned earlier, in some scenarios it may be more beneficial for an investor to offset their loss against their CGT bill. The loss can be set against chargeable gains in the current tax year and/or carried forward to use against future gains.
Similarly to Income Tax relief, the amount of loss relief is then calculated by multiplying the effective loss by the rate at which the taxpayer pays CGT (usually 20% for most capital gains but 28% on residential property gains).
Negligible value claims
If EIS shares have become worthless then it may be possible to make a negligible value claim. Making a negligible value claim allows the owner of the EIS shares to realise a capital loss in respect of an asset without actually having to dispose of it.
By making a negligible value claim, rather than selling an asset, the taxpayer retains ownership should the asset ever recover in value even if this is only a remote possibility. In such circumstances and the asset is sold for a gain then the tax relief received would be withdrawn.
How to claim relief
If you complete a self-assessment tax return, you can claim EIS losses against either Income Tax or CGT by completing the Capital Gains Summary SA108 form. To report a loss against Income Tax, the section titled “Unlisted shares and securities” should be completed. To report a loss against CGT, the same form is used but the loss needs to be assigned against CGT.
The latest version of this form can be found here. This form is a supplementary page to be used when filing the main tax return form for self-assessment known as the SA100 tax return. The SA100 can be found here. These forms can also be completed online.
The relief has to be claimed within 1 year of 31 January following the year in which the loss occurred. An allowable loss made in 2020-21 therefore has to be claimed on or before 31 January 2023. This can be done by amending the earlier returns.
This may result in an overpayment of Income Tax in the relevant tax year. If this is the case, a refund can be requested from HMRC.
S.131 Income Tax Act 2007
In order to qualify, the shares need to be in qualifying companies which otherwise would have been able to benefit from the (S)EIS schemes. I.e. not be an excluded activity. This has an implication when considering whether a business owner should capitalise their own startup funds as equity or whether to put it is as a loan which they can withdraw tax-free and easily in the future.
If the venture is considered a little bit more risky, like a techco startup, then the owner might consider capitalising their own capital funding which should allow them to write off those investment sums against income tax should the business fail.
Of course, there are wider rules to consider about eligibility to claim this relief as well as the elections to send to HMRC so you should seek advice before making any decisions on making a S.131 claim. There are also cross-over calculations which might affect your pensionable allowance and other investment write-offs in a year which may be subject to an annual cap of £50,000.