What is the EIS?
The EIS (Enterprise Investment Scheme) is a scheme introduced by the government in 1994 to help small companies raise funds and grow. When you as a private investor invest in an EIS-qualifying company, you could receive very significant tax breaks.
Companies qualifying for the EIS are small and usually privately owned, although they can be listed on AIM. They will typically have gross assets of less than £15 million at the time of investment and fewer than 250 employees, although there are now more relaxed rules for knowledge-intensive firms.
What kind of companies qualify for the EIS?
EIS-qualifying companies vary significantly, across a wide range of sectors and industries.
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 have significant asset backing or contractual revenue streams have most recently been excluded.
Furthermore, there are restrictions on a company’s age and size (knowledge-intensive companies enjoy a preferential treatment).
Whilst the list of exclusions is fairly long, it does leave huge scope for investors.
What are knowledge-intensive companies?
Broadly speaking, the expression refers to young and innovative businesses. So, for instance, a company which is developing a new drug or treatment would likely fall under this umbrella. A chain of shops opening new sites most likely won’t.
As you would expect, HMRC has set specific requirements a company must meet to be categorised as knowledge intensive.
Those that do can enjoy a number of enhancements to the EIS regime so that they can receive more funding over a longer period of time.
Single company or portfolio?
Broadly speaking, there are two ways to invest in EIS: by investing directly in a single EIS-qualifying company or by investing through a fund or portfolio.
Both options could have a place in an experienced investor’s portfolio.
Investing in a single company gives an investor greater visibility and control, but also carries greater risks because the success of your investment depends solely on the fortune of that company.
Investing in a portfolio or fund affords you some diversification, usually within an area or sector. It also gives you the comfort a professional manager finds and researches the opportunities and makes the investment decision.
On the flipside, you have far less control and visibility over where your money is invested. Moreover, as you would expect, the fund manager’s expertise comes at a price, so investing in a managed portfolio tends to be more expensive than investing in a single company.
Please remember: all EIS investments are high risk and are only suitable for experienced investors.
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 be able to claim the income tax relief?
You can claim the income tax relief after your shares are allotted and you receive your EIS3 certificate.
EIS portfolios tend to be evergreen and the portfolio manager will typically allot shares at regular intervals (it is normally possible to get an indication of when the next allotment is planned).
Single company EIS offers tend to have a closing date – this can be either a set date or, more commonly, the point at which the fundraising target is met. Shares are normally allotted soon after the offer closes.
The date your shares are allotted (not the date you invested) will determine the investment date for tax purposes.
EIS3 certificates are issued after the allotment and after the EIS company receives confirmation from HMRC it has satisfied all the requirements.
Once you receive your EIS3 certificate(s), you can claim the tax relief via your tax return. If you have already filed your tax return, you can still claim the relief.
A claim for EIS tax relief can be submitted up to 5 years after the 31 January following the tax year in which the shares were issued.
How much can I invest in EIS?
The maximum amount you can invest is £1 million per tax year or £2 million, providing anything above £1 million is in 'knowledge intensive' investments. 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.
The minimum investment will vary depending on the investment manager, but it is typically in the region of £10,000.
What is EIS carry back?
EIS investments offer a “carry back” facility. You can elect for all or part of your EIS shares acquired in one tax year to be treated as though they had been acquired in the previous tax year.
This in effect gives EIS investors the option to offset the tax relief against income tax from the previous year.
You can only do this if you have sufficient EIS allowance in the tax year to which you’re carrying back.
What returns could EIS investments offer?
Unlike VCTs, any EIS returns will be mostly in the form of capital growth, rather than dividends.
Each offer will normally indicate a target return, although this is not guaranteed. Target returns vary significantly from around 1.3x to over 10x money invested. As expected, higher target returns reflect higher risks.
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 usually be annual management charges paid to the 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.
In some cases, the investment costs are borne by the investee company, rather than the investor.
How can I buy 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 fundraising target is met 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.
How can I sell my EIS investment?
As EIS shares are not usually traded on the stock market, you cannot sell them the way you would sell an investment 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 the targeted exit strategy and timeframe (typically four years) at the outset. Common strategies include management buy-outs, trade sales or refinancing. However, there are no guarantees.
Please note, EIS are long-term investments. The minimum holding period to retain the income tax relief is three years.
What is EIS Advance Assurance?
This is a service offered by HMRC which companies planning to raise money under EIS may choose to use (it’s not a requirement).
If a company has received Advance Assurance it means it has received a letter from HMRC confirming the company's proposed share issue would qualify for EIS tax relief, based on the information the company provided.
Advance Assurance does not guarantee the company will qualify for EIS tax relief. This can only be confirmed after the company has issued the shares.
Irrespective of whether the company has received (or applied for) Advance Assurance, after it issues the shares it must submit a compliance statement to HMRC. At that point, if all the requirements are satisfied, HMRC will confirm the company is authorised to issue EIS certificates.
Who could consider investing in EIS?
EIS investments are for experienced or wealthy 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 is one of the most generous.
EIS could also be appealing to investors with capital gains tax liabilities as explained on the EIS tax savings page.
What are the key risks?
Like 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 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. Tax benefits depend on circumstances.
What are the main differences between VCTs and EIS?
Despite investing in broadly similar types of companies, there are significant differences between VCTs and EIS investments.
Firstly, the tax reliefs on offer, the maximum you can invest and the minimum holding period are different.
Unlike EIS, VCTs offer no carry back facility: the tax relief can only be offset against the income of the same year in which your shares are allotted. There is also no inheritance tax advantage with VCTs, nor is it possible to offset losses against capital gains made elsewhere.
Secondly, when you invest in a VCT, you acquire shares in the trust, not in the underlying companies. So, theoretically, you could sell your shares any time and realise your investment, although there may be restrictions.
When you invest in an EIS fund, instead, you acquire shares in the underlying companies. As those are not typically listed, you cannot usually sell your shares on the stock market. You can only realise your investment when there is an exit, i.e. the company is sold, listed on a stock market or refinanced.
Thirdly, unlike EIS investments, VCTs tend to pay tax-free dividends, which form much of any return to investors.