EIS loss relief
The Enterprise Investment Scheme (EIS) is a government initiative designed to encourage young and entrepreneurial private companies to grow because of the benefits they bring to the UK economy. So, to encourage investment into companies of this kind – and in recognition of the significant risks involved – the government offers a range of tax reliefs, both when you invest and when you realise your investment.
As can be expected, when investing in these young companies, returns vary. Some may generate positive or even significant returns (in which case the gain is usually tax free) whilst others may fall in value or fail completely. To reduce the impact of any potential losses, one of the tax benefits available for EIS investors is loss relief. This could potentially be claimed for investments in individual companies which have fallen in value, even if an investor holds an EIS portfolio that has delivered a positive return overall.
Here we aim to give a brief overview of EIS loss relief, including the basics of how it can be calculated and claimed. It is not a personal recommendation or tax advice and if you are unsure, please seek professional tax advice. Please remember, tax rules can change and benefits depend on circumstances.
What is loss relief?
Loss relief allows investors to offset a loss made on an EIS company against their income tax or capital gains tax bill.
To qualify for loss relief, the realised value of an investment must have fallen below what is called the ‘effective cost’. The effective cost is the amount invested minus the income tax relief claimed from the EIS investment. For example, if £100,000 is invested and income tax relief of 30% (equal to £30,000) is claimed, the effective cost of the investment will be £70,000.
To claim loss relief, you must have sufficient tax liabilities to offset this against, and you must claim the relief within certain time limits.
Claiming loss relief against income tax
EIS investors should be able to offset a loss against their income tax bill for the current or previous tax year. The amount of tax relief you can claim is worked out by multiplying the value of the effective, or “allowable” loss by their marginal rate of income tax.
For example, if the effective cost of the investment was £10,000, and the investment is eventually sold for £2,000, the allowable loss is £8,000. Assuming a marginal rate of income tax of 45%, the amount that could potentially be claimed as loss relief against income tax would be £3,600 (£8,000 x 45% = £3,600).
Claiming loss relief against capital gains tax
Alternatively, investors can offset their loss against their capital gains tax bill for the current or future tax year. The relief is worked out by multiplying the allowable loss by the rate at which they pay capital gains tax. So, assuming the capital gains tax rate is 20% if you make an effective loss of £8,000 the amount of loss relief against capital gains tax would potentially be £1,600 (£8,000 x 20% = £1,600).
What happens to any deferred capital gains?
If when you invested in EIS you deferred a capital gain, the gain becomes chargeable at the prevailing rate at the date of the disposal of the EIS shares or the liquidation of the company. In effect, the original gain is treated as a new capital gain and must be declared on your tax return. You can use your annual capital gains tax exempt amount against the gain, or you could choose to offset the loss from the EIS investment against the deferred gain
You can still lose money overall, even if you claim loss relief
Due to the high-risk nature of investing in early-stage companies, the value of EIS investments may fall as well as rise and investors may lose part or all of the amount invested. This is still the case even if you claim loss relief. Loss relief will only reduce the impact of a loss, but it will not eliminate the impact entirely.
Tax treatment may change and benefits depend on circumstances
Tax treatment depends on circumstances and can change. Tax reliefs also depend on the portfolio companies maintaining their EIS-qualifying status. For investments in a portfolio of EIS-qualifying companies, it should be possible to claim loss relief for individual holdings sold at an effective loss, even if the overall portfolio performance is positive.
If a beneficiary inherits EIS shares, they cannot claim loss relief if the investment falls in value.
If a beneficiary inherits EIS shares that have fallen in value, they cannot claim EIS loss relief, that might have been available to the original investor.
HMRC considers the shares as having been acquired by the deceased’s personal representatives at their market value at the time of death, even if the shares have lost most or all of their value since the original investment date. Any decrease in value after the point of inheriting the shares, however, may become a capital loss for the purposes of CGT.
Please seek professional advice for more information.
If the value of an investment falls to zero, investors may be entitled to make a negligible value claim.
If shares in an EIS-qualifying company are not sold but are zero (or close to zero), investors may be able to make a claim for the amount of the effective loss. This is called a negligible value claim and can be done by informing HMRC the shares are zero.
How to claim loss relief
If you complete a self-assessment tax return, you can claim EIS losses against either income tax or capital gains tax by completing the relevant part of the SA108 form.
Loss relief claimed through self-assessment may reduce the amount of tax you need to pay for the relevant tax year. This can also be claimed retrospectively, so if too much income tax has been paid HMRC may issue a refund for the excess.
If you have any questions – on this or any other investment matters – please call us on 0117 929 0511 or email us.