Financial products explained
Enterprise Investment Scheme (EIS)
What is it?
The Government introduced Enterprise Investment Schemes (EIS) in 1994 to encourage people to invest in smaller companies. They are designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.
There are three different types of EIS:
Single Company EIS
If you are going to invest in a small business, you may be able to do so through a single company EIS. As the investment is concentrated in just one company, the lack of diversification brings additional risk to this approach. There is often no opportunity to sell your shares unless the company is sold or it has enough cash reserves to buy back its shares.
EIS Portfolio (or unapproved EIS funds)
An EIS portfolio is generally a professionally managed service that invests on your behalf in a number of underlying EIS investments – often at least 10 different companies. Tax relief is available from the date the EIS invests in each company, not when you place your money with the fund manager.
Approved EIS fund
An approved EIS fund must have four or more different underlying companies. HMRC provides clearance of the EIS qualifying status before its launch. This approval has no bearing on the underlying investments or whether the companies will be successful. However, it means income tax relief is given in the tax year the EIS fund closes. Capital Gains Tax (CGT) deferral is not available until the manager has made the underlying investments. The manager must invest 90% of the money in the fund within twelve months of closing its fund raising.
* Please note, whilst the tax regulations refer to Enterprise Investment Schemes as “Funds” they should not be confused with mutual funds or collective investment schemes. An investor in an EIS fund will be the owner of shares in the underlying companies, rather than owning shares or units in any fund.
Unlike Venture Capital Trusts (VCTs), EISs are not quoted on the stock exchange.
The main conditions for gaining EIS relief are as follows:
- Tax relief is given to qualifying individuals who subscribe for eligible shares in a qualifying company.
- A qualifying individual is someone who is not connected with the company when subscribing, although in some circumstances they can subsequently become a paid director of the company.
- A non-UK resident is eligible, but can only claim tax relief against his or her liability to UK income tax.
- Eligible shares are new ordinary shares. No income tax relief is given if more than 30% of the capital is acquired.
- A qualifying company must be unlisted when shares are issued, and must have no arrangements at that time to become a listed company. It must have a permanent establishment in the UK. This can include companies whose shares are listed on the AIM, but with a requirement that gross assets cannot exceed £15 million before the share issue and £16 million after the share issue (up to 5 April 2012 these figures were £7 million and £8 million respectively). The company must have fewer than 250 full-time employees (or their equivalents) at the time the shares are issued.
- Most trades qualify but there are a number of excluded activities including land and property development, hotels, nursing homes, farming, forestry and companies whose activities are mostly involved in financial services or related activities.
- To gain freedom from income tax relief claw back, the investor must hold the shares for at least three years from the later of the date of issue, or the date the qualifying trade begins.
The minimum monthly contribution is normally £25-£50 and the minimum lump sum £500-£1,000. There is no maximum limit although the maximum investment that can qualify for income tax relief is £1,000,000 per tax year.
The tax position on EIS investment is broadly as follows:
- The initial investment qualifies for up to 30% tax relief on investments up to £1 million in a tax year (subject to maximum relief equal to the amount of your income tax liability for the tax year). There is a ‘carry back’ facility which allows all or part of the cost of shares acquired in one tax year, to be treated as though they had been acquired in the previous tax year. Relief is then given against the Income Tax liability of the previous year rather than against the tax year in which those shares were acquired. This is subject to the overriding limit for relief for each year.
- In relation to EIS investments where income tax relief has been given, gains made are free of capital gains tax.
- Losses are allowable on EIS investments where income tax relief has been claimed, although a deduction is made for the 30% income tax relief. Such losses may be offset against income instead of capital gains in the year of disposal or the previous year.
- The payment of tax on a capital gain can be deferred where the gain is invested in shares of an EIS qualifying company. The investment must be made within the period one year before or three years after the gain arose. There are no minimum or maximum amounts for deferral and there is no minimum period for which the shares must be held.
- Inheritance Tax – EIS shares will usually qualify for 100% Business Property Relief after 2 years’ ownership (although there is no guarantee that this will remain the case).
All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.
Generally there is little or no liquidity in EIS companies or funds. EISs are investments in individual unquoted companies and EIS funds can consist of as few as four unquoted companies. Shareholders are normally locked in to the investment with no means to dispose of the shares, until the company directors or fund managers achieve an exit (e.g. quoted market flotation, trade sale or share buy-back). Not all companies/funds offer the ‘share buy-back’ facility which may be a factor worth considering for the prospective investor. It would be prudent to view these investments as medium to long term.
Guaranteed exits are not permitted under the EIS rules.
There are a number of risk considerations that need to be taken into account. It is important that you are aware of these.
- Governments can and do change the rules on tax in respect of investments such as EISs.
- Income generated from investments held in EISs is variable and is not guaranteed. The level of income generated by dividends is likely to be low and will be used in the first instance to offset charges.
- The price of shares and the income from them can fall as well as rise.
- The value of this investment is not guaranteed and if encashed, it is possible you may not get back the full amount invested.
- The investment can grow but depending on market conditions you may not realise the initial sum invested. There is no guarantee that you will get more out of an EIS investment than you have paid in.
- If income tax relief is not given on your investment or is subsequently withdrawn, if upon realisation your total gains (from all sources) less any allowable losses are greater than your annual Capital Gains Tax allowance, there will be tax to pay at either 10% (basic rate band), 20% (higher/additional rate band) or a mixture of both rates depending which tax band(s) the gain falls into after adding to total taxable income for the tax year.
- EISs are high-risk investments. An EIS investment is usually concentrated in one single unquoted trading company, unlike Venture Capital Trusts (VCTs) which invest in a 'basket' of such companies, thus achieving some spread of risk.
- Tax incentives may be lost if the investment is not held for 3 years. This may occur even if it is the fund manager (and not the investor) who disposes of the asset.
- Flotation will trigger loss of IHT Business Property Relief and, if within 3 years, loss of other tax reliefs.
- The failure rate of EIS companies is typically much higher than that of larger companies.
- Tax relief may not be granted if information provided to HMRC is incorrect or inaccurate.
- Past performance should not be used as a guide to future performance.
- Generally there is little or no liquidity and investments may be difficult or impossible to realise at an appropriate time.
- Investment in EISs is high risk and you may lose all of the capital invested.