A Guide To The Enterprise Investment Scheme

As part of our alternative investment series, we look at the Enterprise Investment Scheme and how investors can use it as part of their wider investment portfolio.

WHAT IS THE ENTERPRISE INVESTMENT SCHEME?

The Enterprise Investment Scheme (EIS) was established by the UK government in 1994 to encourage individuals to invest in small unquoted trading companies.

By way of incentive, the government introduced a number of tax benefits for investments into these companies, the most pertinent of which is a 30% tax reduction on investments up to £1,000,000 (available in either the current or prior year).

As well as the tax benefits, investors also benefit from the performance of the underlying EIS companies.

HOW DO EIS FUNDS WORK?

As well as investing directly into EIS qualifying companies, you can also invest through an EIS fund, which will invest in a number of qualifying companies on your behalf. You are still the owner of the shares.

Unlike other forms of tax-advantaged investment, there is no limit on the number of EIS investments that you can make in one tax year. However, for any given tax year, EIS tax reliefs are only available on EIS investments of up to £1m and joint investments are not allowed as an EIS needs to be held in the name of one person.

WHO IS AN EIS INVESTMENT SUITABLE FOR?

Investments into EIS qualifying companies are most suitable for UK taxpayers to whom any of the following apply:

• income tax liability in the current or previous tax year
• capital gains to defer
• would benefit from inheritance tax relief

HOW DO INVESTORS CLAIM TAX RELIEF?

Tax advantages can be claimed when EIS-qualifying shares have been acquired, and you have received the EIS3 certificate relating to the shares. You can apply the relief to income tax due in the tax year the shares were purchased, or carry it back against income tax paid the previous tax year.

BENEFITS OF THE ENTERPRISE INVESTMENT SCHEME

INCOME TAX RELIEF

• Reduction in income tax liability amounting to 30% of the total investment up to a maximum of £1,000,000
• Income tax relief on investments of up to a further £1,000,000 can also be carried back to the previous tax year
• Relief cannot exceed an amount which reduces the investor’s income tax liability to nil

CAPITAL GAINS TAX DEFERRAL

Facility to defer paying capital gains tax (CGT) on all or part of a chargeable gain by investing the proceeds in qualifying EIS shares.

Applies to any chargeable gains arising three calendar years prior to, or one year after, the issue of qualifying EIS shares.

Gains are deferred until a chargeable event e.g. disposal of the EIS shares or earlier breach of the EIS rules.

TAX FREE GROWTH

There is no CGT payable on gains realised on disposal of EIS investments, if income tax relief is claimed. This applies if you have received income tax relief (which has not subsequently been withdrawn) on the cost of the shares, and the shares are disposed of after they have been held for a certain period (usually three years), any gain is free from CGT.

SHARE LOSS RELIEF

If EIS shares are disposed of at a loss, you can elect that the amount of the loss, net of any income tax relief given, can be set against your income in the year in which the shares are disposed of, or the preceding year, instead of being set off against any capital gains.

INHERITANCE TAX RELIEF

Investments qualify for business property relief so are exempt from inheritance tax after two years, as long as you still own the shares on death. Any income tax relief you claimed will not be clawed back, and any deferred capital gains will be permanently extinguished.

The investment manager will usually liaise with your executors to arrange the transfer of shares to a beneficiary. If the shares are subsequently sold, they will be subject to CGT, taking the value at the point of transfer as the acquisition cost for the purposes of calculating the gain.

WHAT ARE THE RISKS OF AN EIS?

Like any investment, investing in an EIS company involves risks, and it is important that investors understand these risks before deciding whether it is the right investment vehicle for their needs. Investors must be prepared for the value of their investment to go down as well as up, meaning they may not get back as much as they invested. Furthermore, the past performance of investments made into an EIS company should not be regarded as a guide to future performance.

The level of returns, availability and timing of relief for investors may be impacted by:

• Returns generated by the investee companies
• The availability of investment opportunities for the fund manager
• The EIS qualifying status of investments made by the fund manager

THE TAX ADVANTAGES MAY CHANGE

As with many other types of investment, tax rules, levels and regulations are subject to change and the availability of the tax reliefs will depend upon individual circumstances.

EIS INVESTMENTS SHOULD BE CONSIDERED AS A MEDIUM-TERM INVESTMENT

Investments made into an EIS company are likely to be illiquid. They cannot typically be sold or partially withdrawn at your request, and they must be held for at least three years to benefit from tax advantages. Some may be held for considerably longer. You will not generally be able to access your funds until the companies you have invested in are sold or listed on a stock exchange. You should check the likely investment duration before subscribing.

IMPORTANT INFORMATION

This guide does not offer investment or tax advice. You should only invest on the basis of the information contained in the relevant brochure and/or investor agreement, and we recommend that you take independent financial advice before making your decision.