Introduced in 1 January 1994. The EIS scheme replaced the ‘Business Expansion Scheme’ (BES), which was more lucrative and covered some less risky companies.
While EIS hasn’t been as popular as BES for these reasons, as you’ll see below, it still offers substantial tax breaks to investors who want to back small businesses.
EIS is designed to help certain types of small, high-risk, unquoted companies raise capital, by offering tax relief to investors who subscribe for new shares.
Please note that the author performed research to ensure that the content of this article was accurate at the date of initial publication (2012) however tax laws are subject to change, and EIS have very complicated tax rules. Here is a link to the HMRC guide to EIS for up-to-date information.
Enterprise Investment Schemes are only appropriate for sophisticated investors due to the complexity of these tax rules and the high risk of loss from investing in small businesses.
Tax Relief from investing in EIS
Income Tax Relief @ 20%
Since 2008, for investments between £500 and £500,000 per year, EIS gives 20% tax relief, which reduces the investor’s income tax liability by 20% of the amount invested.
For example, if an investor buys £250,000 of shares issued by an EIS company, they could reduce their current year income tax liability by £250,000 * 20% = £50,000.
The relief is used to reduce the income tax liability of the tax year in which the shares are issued by the EIS company. Investors can also claim to apply the relief against the tax liabilities of the previous tax year too.
If an investor has insufficient income tax liabilities in the current or previous tax year, they may not enjoy the full benefit of the tax relief.
Other notes on claiming income tax relief:
- Can only make a claim after the business has been trading for 4 months.
- Relief is withdrawn if the shares are disposed of within three years of issue. Exceptions are if the shares are transferred to a spouse, or if the investor dies.
What investments qualify for EIS income tax relief?
Tax relief is given to (1) qualifying individuals who subscribe for (2) eligible shares in a (3) qualifying company carrying on a (4) qualifying business activity.
- Qualifying individuals are:
- Unconnected to the company (not a director or employee at date of subscription)
- British citizens or non-UK residents. However non-UK residents can only claim relief against UK income tax liabilities.
- Eligible shares are:
- New ordinary shares
- Represent less than a 30% stake in the company for income tax relief to apply (CGT deferral relief still available on larger stakes)
- Qualifying companies are:
- Unquoted, with no current plans to list its shares on a stock exchange.
- Fewer than 50 full-time employees at date of subscription
- Gross assets must not exceed £7m pre or £8m post EIS investment.
- Companies which have not raised £2m to date using Venture Capital schemes in two years up to the date of the EIS funding round.
- Qualifying business activity is
- Wholly or mainly based in the UK
If the EIS shares were held for at least three years, and qualified for income tax relief, will be exempt from CGT altogether.
CGT Deferral relief
Another tax advantage conferred by the EIS scheme, is deferral of capital gains tax on the EIS shares. This tax would normally be charged when EIS shares are disposed of at a profit in the future.
Deferral is allowed if the proceeds of the sale are reinvested into another qualifying EIS company during the qualifying window.
The qualifying window begins one year before the disposal, and three years after.
This is a deferral of the chargeable gain, not a deferred of a specific CGT tax amount. The final CGT to pay will therefore be based upon the rates applicable at the date the gain is eventually taxed.
Gains can be deferred multiple times, so long as the gains continue to be rolled over into qualifying EIS companies.
No upper limit to the size of the chargeable gain that can be deferred.
Business Property Relief
If shares in unquoted companies are held for at least two years, they qualify for 100% business property relief, which means they may attract 100% relief from inheritance tax.
The Risks of Investing in an EIS Scheme
High risk. Qualifying companies are small turnover businesses by definition. These are high-risk enterprises with a real risk of failure during the period the shares are held. Investors must accept the risk of the total loss of an EIS investment if the company fails.
Liquidity. To qualify for EIS income tax relief and CGT exemption, shares must be held for 3 years. Even after this time, an investor may find it difficult to dispose of unquoted shares, as this is an illiquid market with a low volume of transactions, and a manual search to find a buyer.
When selling shares in an EIS scheme, similar tax relief will not be available to the buyer of the shares, as they are not new issues. These shares are therefore less attractive to investors, who may prefer to invest directly in a new EIS scheme to access the tax relief.
Tax rule changes. Tax rules may change. The headline income tax relief is claimed within a year of subscribing to the new shares, however, the longer-term reliefs such as CGT deferral or CGT exemption are subject to change due to new legislation.
It is for this and other reasons that you should never use tax relief/efficiency as the primary decision making factor when making an investment.