Enterprise Investment Scheme (EIS)
Enterprise Investment Schemes are investment opportunities for individuals looking to invest in unlisted companies.
EIS was launched by the Government in 1994 to help smaller higher-risk trading companies to raise finance i.e. companies whose shares, stocks, debentures or other securities are not available to be bought or sold publicly. Investors were, and still are, incentivised to make an investment in return for a range of impressive tax breaks.
As an incentive for private individuals to put their personal capital to work in the economy, the UK Government is effectively offering to fund up to 30% of private investment, in the form of an income tax rebate of tax paid.
For example, an investor earning £150,000 (who pays over £50K in income tax each year) could comfortably invest £100,000, buying a portfolio of shares in qualifying companies, and so qualify for a tax credit from HMRC of £30,000. The net cost of buying the £100K portfolio has therefore only ‘cost’ the investor £70,000.
The skill of the financial adviser is to select high quality investments that qualify for the tax incentives. Investments of this nature are reasonably complicated and require careful consideration before any capital commitment is made.
We strongly recommend anyone looking to take advantage of the current tax breaks on offer by investing in this way, seeks advice from a suitably qualified investment professional.
Call us on 0207 101 2817 to arrange a free initial meeting to explore your options in detail.
How is an EIS structured?
Investors buy shares directly in EIS qualifying companies.
To qualify for EIS status, the investee companies must be unquoted and not listed on an exchange. Investors are free to either source attractive businesses for direct investment themselves or use a third party investment intermediary. Such intermediaries have the expertise to source a selection of EIS qualifying companies, often marketing EIS as a ‘product’. Investors who want to invest in this product then deposit funds with the intermediary who in turn will then purchase shares in the actual companies on the investors’ behalf.
The intermediary will issue an information memorandum explaining the background to the EIS opportunity, the individual companies involved, the rationale behind the investment ideas and the potential returns that may be achieved.
What are the tax benefits?
- Income Tax relief at 30%
Immediate relief is available on a maximum investment of £1,000,000; it is possible to use ‘carry back’ allowing all or part of the cost of the shares acquired in one tax year, to be treated as though those shares had been acquired in the preceding tax year. It is therefore possible to create a tax reduction of up to £300,000 in any one given year.
- Business Property Relief (BPR)
BPR is available after two years of investment; effectively means that the asset, if held until death, falls outside of the owner’s estate on death
- Capital Gains Tax deferral
If you acquire EIS shares then it is possible to defer gains in the previous 36 months until such a time as the EIS shares are disposed of. This has always been a useful relief but is even more useful now that the top rate of capital gains tax has reduced from 28% to 20%. Now taxpayers can use this relief to swap a 28% tax rate for a 20% tax rate for gains that occurred in the last 3 years. This extra 8% will augment the 30% income tax relief that is also often available. Deferral allows the gains made on a disposal to remain deferred for the life of the investment.
- No Capital Gains Tax
If held for the full three years, there is no CGT on the sale of the shares
- Loss relief
Loss relief can be used above and beyond the income tax relief granted
NB: The Budget on 22 June 2010 announced that after that date it is no longer possible to defer gains under EIS, and at the same time for them to qualify for Entrepreneur’s Relief.
What are the risks?
Primarily there are two main risks associated with EIS investment: Investment Risk and Liquidity Risk.
You can lose all or some of your invested money. By buying shares in small or start-up companies an individual faces much greater risk than investing in their more established mature counterparts.
An EIS intermediary will try to mitigate this risk by:
- Spreading investor’s money across a number of different companies.
- Investing in more mature or lower risk businesses or those that own real assets e.g. property.
- Selecting the companies carefully and follow a rigorous process of due diligence.
There may not be a market to sell your EIS shares. An investor must retain his EIS shares for a minimum of 3 years to keep the 30% income tax relief given. The second hand market for these shares may be limited especially as the income tax relief is not given to the purchaser.
EIS intermediaries will try to mitigate this risk by:
- Offering to buy back their own shares.
- Structuring the EIS as a planned exit or limited life offering.
What approaches to EIS investment are there?
- Single Company EIS
An investment in a single company that has successfully been approved for EIS status is at the most risky end of the EIS scale
- Portfolio of EIS companies
A portfolio approach sees a manager or intermediary create a portfolio of EIS approved companies.
- Approved EIS funds
Approved EIS funds have had their business strategy reviewed by HMRC, this is no guarantee that this type of EIS is even safer than other types of EIS. With this kind of EIS there are some different timing consequences around the prevailing tax perks offered through the EIS
EIS investment is high risk and should rarely if ever form a large portion of an individual’s investment portfolio. Whilst the tax benefits of EIS investment are attractive, the tax incentives alone should not be the sole reason to make an investment.
EIS investments should be used to complement other more mainstream investments via open ended tax structures and should normally only be considered when other tax allowances have been used up.