What is the EIS?
The EIS (Enterprise Investment Scheme) is a scheme introduced by the government to help small companies raise funds and grow. When you as a private investor invest in an EIS-qualifying company, you receive very significant tax breaks.
Companies qualifying for the EIS are small and unquoted, with gross assets of less than £15 million at the time of investment and less than 250 employees.
What kind of companies qualify for the EIS?
EIS-qualifying companies vary significantly: from asset backed, to higher-risk early stage.
The rules are fairly specific, but essentially to qualify a company needs to carry on a trade with a view to making a profit. Some companies and sectors are excluded, for example those that deal in land, commodities or shares. Companies that benefit from the renewable energy feed-in tariff are also now excluded.
Whilst the list of exclusions is fairly long, it does leave huge scope for investors. Popular investments over the past few years have been high tech, renewable energy companies (which no longer qualify for EIS) and those investing in public houses.
Single company or portfolio?
The first decision you face as an investor is whether to invest in a single company or a managed portfolio. As you would expect, the first option carries far greater risk because the success of your investment depends solely on the fortune of a single small company.
Managed portfolios, on the other hand, tend to offer a greater spread of risk as they invest in a number of companies, often in different sectors and with different characteristics.
In many respects, deciding between a single company and a managed portfolio is similar to deciding between individual shares and a unit trust. There is an important difference though. It is relatively easy to research a company such as Vodafone. There is plenty of information and commentary publicly available. What’s more, selling those shares is usually just a click or phone call away.
The same cannot be said for investments in small unquoted companies. The information is scarce and relatively inaccessible. Crucially, the exit needs to be carefully planned – there is no established route. A good fund manager will take care of both these issues: they will select and carry out due diligence and will design a strategy for exiting the investment.
As you would expect, the fund manager’s expertise comes at a price, so investing in a managed portfolio is more expensive than investing in a single company.
That said, we believe there are managers who more than earn their fees.
What are the tax breaks?
Investors can benefit from a mix of upfront and ongoing EIS tax reliefs:
- Up to 30% income tax relief
- Tax-free growth
- Capital Gains deferral
- Inheritance Tax relief
- Loss relief on exit
Please remember: tax rules can change and benefits depend on your circumstances. EIS tax benefits are only available if the company maintains its EIS status.
If I invest today, when will I receive the income tax rebate?
You can normally obtain the tax rebate for the tax year in which you invest. In practice, though, the product provider may take some time – at least 6 months – to issue the EIS3 form you need to claim income tax relief. If you haven’t received it by the time you complete your tax return, don’t worry. You can still claim the tax rebate even if you have already paid your tax bill.
How much can I invest in EIS?
The maximum amount you can invest is £1 million per tax year. In theory, it’s possible to invest more. You wouldn’t qualify for income tax relief on the excess, but would still qualify for capital gains deferral and IHT relief. Income tax relief can be carried back to the previous tax year if desired.
What returns can EIS investments offer?
As one can expect, investing in EIS-qualifying companies is a case of high risk/high potential reward.
Any returns will be mostly in the form of capital growth, rather than dividends.
Smaller companies are more likely to fail than their larger counterparts. That said, if the investments don’t work out, the government effectively caps losses at 38.5% for additional rate-taxpayers, through loss relief. In other words, the tax benefits provide a buffer: they mitigate the impact of losses and amplify the impact of gains.
What are the charges?
The charges vary depending on the type of investment and whether it is an EIS managed portfolio or a single EIS company. Within a managed portfolio, there will be annual management charges paid to the underlying manager as well as initial fees and often performance-related fees. With an individual company EIS, there may be an initial fee; however, there may not be explicit annual management fees, as essentially the cost of running the company is the cost of doing business.
How can I buy and sell EIS investments?
Unlike VCTs, EIS investments are not traded on the stock market. Typically, you invest through a specialist broker, such as Wealth Club.
EIS offers are often available all year round, but each offer is only open for a specified period. However, if the fund raising target is hit before the official deadline, as is often the case with the most popular EIS, the offer closes. There are many EIS – individual companies and portfolios.
What if you want to sell your EIS investment?
As EIS are not traded on the stock market, you cannot sell the investment the way you would sell a unit trust. Instead, it is the managers’ responsibility to design an exit strategy that allows them to return capital and any tax-free growth to investors.
The manager will usually give an indication of their targeted exit strategy and time frame (typically four years) at the onset. Common exit strategies include management buy-outs, trade sales or refinancing. However there are no guarantees the manager will find a suitable exit.
Please note, EIS are long-term investments. The minimum holding period to retain the income tax relief is three years.
Who could consider investing in EIS?
The EIS was introduced in 1993 to encourage private investors to provide venture capital for unquoted companies.
Since then 22,900 companies have received over £12.3 billion.
However, EIS investments are only suitable for some investors as part of a diversified portfolio.
They could be particularly attractive to investors with a large income tax bill who are looking for growth opportunities. The EIS allowance of £1 million per tax year is one of the most generous.
EIS could also be appealing to investors with capital gains tax liabilities. Even more so after the reduction in the top rate of capital gains tax from 28% to 20% as explained on the EIS tax savings page.
What are the key risks?
Like with all investments, the value and income from them can fall as well as rise so you may get back less than you invest.
However, as they invest in small companies, this risk is greater with the EIS than with other stock market investments. Small companies are more volatile and more likely to fail than their larger counterparts.
For this reason, EIS investments are long-term investments and are not for everyone. They are for high net worth or sophisticated investors who have no need for immediate liquidity and are able to withstand a potential total loss.
In addition, as there is no recognised market for these shares, EIS investments are less liquid than other stock market investments and they will be harder to sell.
Lastly, to retain all the tax reliefs available, you must hold the investment for a minimum period of three years and the companies must retain their qualifying status. Otherwise, you may have to pay back the income tax relief you have received.
Please remember, all the tax and products rules mentioned here are those currently applying but could change in future.