Enterprising Outlook

Enterprising Outlook

The Enterprise Investment Scheme (EIS) is one of the most tax advantageous investments in the UK. The tax structure is designed to encourage high net worth individuals to provide unquoted businesses with much needed funding.

Over the past few years, the majority of EIS fund raising has been in the packaged “capital preservation” sector, which has relied on a combination of asset backing, predictable revenue streams, government incentives and pre agreed contracts to deliver “cash plus” returns to investors. However following the Patient Capital Review and subsequent Budget, most of these trades will no longer qualify for EIS reliefs and fund raising will focus on more traditional, much higher risk growth strategies.

EIS are unsuitable for most investors. Before considering an investment, investors will typically have maximised ISA subscriptions and pension contributions. They may even have invested in VCTs which have some similarities to EIS, but are generally considered a little lower risk.  However, EIS should not be discounted based on risk alone, as the tax structure helps to reduce some of the risks. 

Income Tax

Up to £1M, rising to £2M in April for investment in “knowledge intensive companies”, can be invested in a tax year and income tax relief of up to 30% claimed. This is a tax reducer so the income tax must have been paid by the investor in order to claim the tax relief. For instance, an investment of £10,000 in an EIS will allow the investor to reduce their income tax bill by £3,000. Investors may also treat some or all of the investment as if it had been made in the previous tax year. The minimum holding period to ensure income tax relief is not subject to clawback is three years.  From outset therefore, investors have an immediate 30% cushion before they incur a capital loss.

In addition, any EIS losses incurred can be offset against income (or gains if there is insufficient income to support the relief). The loss relief is limited to the net investment i.e. where an investor loses their entire £10,000 the maximum they can offset against income is £7,000. This means that as long as the investor is able to claim the maximum reliefs, a higher rate tax payer’s maximum loss is 42% of the capital invested and 38.5% for additional rate tax payers.

Capital Gains Tax

Any gains from the sale of EIS shares are not subject to capital gains tax provided the investor claimed income tax relief at outset and has held the shares for three years.

An investor who makes a capital gain from the disposal of another asset can defer the liability on that gain by investing the amount of the gain in an EIS qualifying company.  The investment must be made during the period one year before and three years after the date of the disposal which gives rise to the gain. It is important to remember that the capital gains tax relief is only deferred and the original gain will re-crystallise on the disposal of the EIS shares, however this would be subject to tax at the prevailing rate at the time is crystallised, not from when it is deferred.

Inheritance Tax

We have increasingly seen EIS used as a way to mitigate inheritance tax. Provided that the EIS shares have been owned for at least two years and that certain conditions are met, 100% Business Relief should be available.  Where this is the case, the shareholding is essentially free of inheritance tax. 

Investing in EIS

Whilst the tax reliefs help to reduce some of the risk, as always it is prudent to ensure a well-diversified portfolio of EIS companies. There are various ways of achieving this including:

  • Investing via a dedicated investment platform such as Growth invest or Crowd cube.

  • Using the services of a specialist discretionary investment manager or investing via an unapproved EIS fund.

  • Investing in an approved EIS fund.

The last of these is interesting as it reduces the administration of investing in EIS. To claim tax reliefs, the company will send investors an EIS3 certificate which it cannot do until the company has been trading for at least 4 months. If you have invested in 10 companies, this means you will receive 10 EIS3 certificates. In some circumstance, these can be delayed for a number of months, possibly being issued after you have completed your tax return.

An approved EIS fund, on the other hand, will only issue one EIS5 certificate, with all investments being treated as having been made in the EIS fund at the date in which it closes. Investors cannot carry back to the previous tax year in this type of arrangement and the rules around the timing of investments by the manager are more onerous. This entry point to EIS does provide more certainty than the unapproved fund/portfolio approach, albeit approved funds are very much in the minority currently.

As part of the Patient Capital Review, the government is seeking to introduce a new knowledge-intensive approved EIS fund structure, with more details to be released at a later date.

The unique combination of reliefs makes EIS a very interesting investment in smaller companies where the potential rewards are great, but at a significant risk to capital. Unless you are a confident investor, it would be sensible to take advice from a specialist in this market. 

Tom Lloyd Read, Chartered Financial Planner
Head of Advice

Commentary first appeared in:

What Investment - Enterprise Outlook (in print on 1st April 2018)

Opinions, interpretations and conclusions expressed in this document represent our judgement as of this date and are subject to change. Furthermore, the content is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or a solicitation to buy or sell any securities or to adopt any investment strategy.

Thomas Miller Investment is the trading name of the businesses in the Thomas Miller Investment Group. This note has been issued by Thomas Miller Wealth Management Limited which is authorised and regulated by the Financial Conduct Authority (Financial Services Register Number 594155) and is a company registered in England, number 08284862

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