Investing in small companies is not for the faint-hearted. Whilst some of these companies might do very well, others will struggle and some will fail.
The tax incentives the government offers provide a valuable buffer against this risk for Enterprise Investment Scheme (EIS) investors. They mitigate the impact of investments that don’t work out and amplify the impact of investments that do well.
Please remember though: tax rules can change and benefits depend on circumstances.
EIS tax relief at a glance
Income tax relief of up to 30%
A £100,000 investment could provide a £30,000 saving on that year’s income tax bill. To claim this, you must have sufficient income tax liability in the first place and hold the shares for at least three years.
Generous contribution allowance
Invest up to £1 million per tax year or up to £2 million if anything above £1 million is invested in knowledge-intensive companies.
Carry back contributions to the previous year, assuming you have the allowance. Carry back also gives you the option to offset the tax relief against the previous year’s tax bill, so you could potentially get back tax you’ve already paid.
You normally pay no CGT when realising EIS shares, if you have claimed income tax relief on them and the companies still qualify.
Capital Gains deferral
If you have realised a taxable gain (e.g. by selling investments or a second home) and invest the proceeds in an EIS, you can defer the capital gain for as long as the money stays invested. You can defer gains of any size, made up to three years before and one year after the EIS investment. You can defer a gain even if you have already paid the tax. Once you get your money out, the gain comes back into charge and you pay CGT at the prevailing rate. Alternatively you could invest into another EIS and continue to defer the gain. To benefit, you must have had the income tax relief.
Inheritance tax relief
An investment in an EIS-qualifying company should benefit from 100% relief from inheritance tax, provided the investment is held for two years and at the time of death.
If things don’t go to plan, you can choose to offset any loss, less the income tax relief received, against your income tax bill. So, an additional-rate taxpayer could effectively reduce a total loss of £1 to 38.5p.
How EIS tax relief helps reduce any losses and magnify any gains
When you invest £100,000 in an EIS, because of the income tax relief of up to 30%, the effective net cost could be as little as £70,000. The table below gives examples of how that – and loss relief – might affect your returns whether your investment does well or badly.
Loss relief allows you to write off any losses against income tax. So, if your investment falls to zero you could in effect deduct the £70,000 loss from your taxable income. This gives a potential tax saving of £31,500 and means the maximum effective loss could be as little as £38,500 (effective cost of £70,000 less loss relief of £31,500). Meanwhile, if your investment grew by 50%, thanks to the tax relief, you could be looking at an effective gain of 80%.
|Investment falls to zero||Investment falls by 50%||Investment has no growth||Investment grows by 50%|
|Net cost of investment||£70,000||£70,000||£70,000||£70,000|
|Investment value on realisation||£0||£50,000||£100,000||£150,000|
|Effective gain/loss after tax reliefs||(£38,500)||(£11,000)||£30,000||£80,000|
|Effective gain/loss after tax reliefs||(38.5%)||(11%)||30%||80%|
How do I claim EIS income tax relief?
You can normally claim EIS tax relief when you file your tax return. You’ll either reduce your tax bill for the year or receive a refund for tax you've already paid.
How do VCT, EIS and SEIS tax reliefs compare?
|Maximum investment||Income tax relief||CGT relief / deferral||Tax-free dividends||Tax-free growth||IHT relief||Loss relief|
|EIS||£2,000,000*||30%||deferral||no||yes||after 2 years||yes|
|SEIS||£100,000||50%||50% relief||no||yes||after 2 years||yes|
What happens to my EIS shares when I die?
EIS shares are treated like any other shares you buy in the stock market. This means when you die they form part of your estate and can be passed on to whomever you choose. There is one important difference though: EIS shares could be IHT free.
Should the death occur within three years from the investment, there is no clawback of any of the tax reliefs. IHT relief, however, could only be available if the shares have been held for at least two years.
Any beneficiary who receives the shares will not benefit from any EIS tax reliefs, so capital gains tax might be due on any gain compared with the value at the date of death of the deceased.