What is the Enterprise Investment Scheme tax relief for investors
Think Dragons Den. It is highly likely the Dragons are qualifying for EIS tax relief on their investments (you'll find they always invest less than 30%)
EIS tax relief is a government initiative for investment in small high-risk companies. Small companies often struggle to get traditional funding such as long-term bank loans, overdrafts, credit card debt and access to short-term working capital finance. This is because a bank cannot secure loans on a business with no assets and no proven future income streams. This sector is vital to a successful economy and because the government cannot write a blank cheque for start-ups they instead offer generous tax reliefs to individuals to invest into these types of companies. This is known as EIS tax relief. There are 4 main benefits which are all explained below with examples.
This is a tax refund from HMRC for investing into a qualifying EIS income company. The tax relief is given through the self-assessment tax return. It is given at a rate of 30% of the investment value. A EIS tax relief example, you invest £100k into a qualifying EIS scheme and your income in the year is £100k and your tax bill for the year is £40k. You can make a claim to HMRC for a tax repayment of £30k. This means you only pay £10k in tax in the year. In addition, you have flexibility to claim the repayment in the previous tax year (if for example your income/bonus is lower in the current year).
This allows you to set off the loss on the investment against your general income therefore reducing the cost of the investment down to only 38.5% (if you are an additional rate taxpayer). Continuing from the example above, 4 years after holding the investment the company fails, goes into a liquidation and as a shareholder you receive NIL value for your shareholding. You have suffered a £70k loss (that is the £100k investment you made, less the £30k tax relief you already received from HMRC). The relief is given by reducing your taxable income in the year therefore triggering a tax repayment for overpaid tax. By way of an example for an PAYE individual, your taxable income in the tax year is £250k, the share loss tax relief reduces your income to £180k and you get a repayment of tax because you already paid income tax on your £250k salary.
- 3. Zero Capital gains tax
If after the 3-year holding period the business is a tremendous success and the shares are purchased by a private equity fund (for example), your gain is free of capital gains tax. By way of an example, you subscribed for £100k in EIS qualifying shares you sell them for £150k, there is no capital gains tax to pay.
- 4. Capital gains tax deferral relief
If you dispose of a property and make a £100k profit, you will normally have to pay capital gains tax on this disposal. However, if you subscribe to EIS qualifying shares then you can "defer" the gain, that is delay the payment of tax, on the gain until such a point you sell the EIS qualifying shares. It basically means instead of paying your tax now, you can invest that money into an EIS qualifying company (and get EIS income tax relief). There are of course commercial risks here such as the EIS company failing in which case you would still have to pay the capital gain tax and would need to find the money by some other means.
How many shares can I buy
You cannot hold more than 30% of the shares in any single EIS company. This includes "associated" holdings such as those with your spouse/civil partner and/or children.
What happens if an EIS company loses its qualifying status
You are in trouble because you will lose all the tax reliefs. So, for example, you would need to repay the EIS tax relief you previously claimed.
What evidence will you need to make an EIS claim
The qualifying company will issue you with an EIS3 - this is a certificate that confirms you own the shares and that they are qualifying.
An EIS company I previously acquired shares in has invited me to purchase additional EIS shares
This is perfectly normal; a Company can raise £12m in its life and £5m in any one year. (Although this might commercially not be a good bet as your shareholding in the business potentially decreases and could be a stress signal. If a company runs out of cash once, it will probably run out of cash again).
The tax reliefs are generous because the risks are big. For example, property development companies are not EIS qualifying (because they tend not to be risky). As an investor, the one of the biggest risks to your investment (other than the business failing) is the risk of losing HMRC qualifying status. As the scheme is generous, the tax rules are rigid, and many companies fall foul because the compliance costs (accounting and taxation) can be high, and they therefore try to cut corners or just assume things will be ok because HMRC provided approval on application. There are several conditions a qualifying company must meet (and continue to meet) to maintain its qualifying status. For this reason, you should only invest in an EIS scheme that is recommended by a qualified financial advisor. Most EIS companies will apply for "advance assurance", this is like a blessing if you like from HMRC before the Company issues EIS shares. The other thing to watch out for is rouge EIS qualifying companies that don't have a good governance set-up in place. This is a recipe for disaster.
The article is written with the tax benefits in mind, always consult with a financial advisor before making an investment.
Contact Us to discuss your personal taxation circumstances.