EIS companies offer various tax benefits but they are still risky investments.
As touched on in previous articles, the Government does actually want you to invest in shares, and is so keen on the idea, the taxman will give you a whole host of income and capital gains tax reliefs. The catch? Well, you didn't seriously expect something for nothing did you? The catch is that, in order to benefit from the reliefs, you must make 'risky' investments, which kind of goes against the ethos of a savvy Foolish investor.
EIS schemes
Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) are similar types of tax-favoured investments, the major difference between the two being that EIS relief refers to investment in a specific company, and a VCT is an investment trust vehicle that itself invests in 'risky' companies. (I look at VCTs in more detail in this article)
Both reliefs offer income and capital gains tax (CGT) advantage, provided certain qualifying conditions are met, by both the individual investor and the investee company or fund.
EIS is perhaps more commonly known, and offers more opportunities for tax relief, as detailed below.
The facts
Potential EIS investors must:
- subscribe for ordinary shares (i.e. the shares have no preferential rights and are issued by the company, not purchased from a selling individual);
- invest a minimum of £500 per company per tax year;
- hold the shares for a minimum qualifying period (normally 3 years); and
- not be 'connected' to the company, by way of employment or association or by owning 30% or more of the share capital (this does not apply for CGT deferral relief below)
The EIS investee company must:
- be unquoted (which includes AIM and PLUS shares);
- have gross assets, or aggregate gross assets of the group, not exceeding £7m prior to investment nor £8m post investment;
- have fewer than 50 employees and cannot have raised more than £2 million from Venture Capital Trusts, the EIS or the Corporate Venturing Scheme in the last year (ignoring transactions prior to April/July 1997);
- be raising money for a business activity of a qualifying trade carried on wholly or mainly in the UK during the three years from when the shares are issued or, if later, three years from when the company commences to trade. Qualifying trades encompass all forms of trading except for certain prohibited businesses including dealing in land, financial activities, legal/accountancy services, property backed activities, shipbuilding, as well as coal and steel production; and
- apply all the money raised by the issue of EIS shares in qualifying business activities within two years of the share issue, or where it is a new trade, within two years of the start date
Income Tax relief
Qualifying investments, up to a maximum of £500,000 will be eligible for income tax relief at 20%, giving a maximum of £100,000. This maximum is subject to the investor having a sufficiently large tax liability to absorb the relief, but amounts may be carried back to the previous tax year in order to ensure maximum relief is obtained.
If the EIS shares generate a capital loss, this is allowable for tax purposes, but it is also possible to utilise the amount of the loss, less any income tax relief, against income instead of gains. This is a specific relief applying only to this type of tax-favoured investment and differs from normal treatment of capital losses.
Capital Gains Tax relief
Any gains arising on the EIS shares themselves are not chargeable to CGT, which is far less generous than it sounds, given the shares are 'risky' and far more likely to generate a loss than a gain.
For EIS schemes only, a separate relief for reinvestment can defer CGT arising on gains incurred in the period from one year before the EIS subscription to three years afterwards. The deferred gain does not become chargeable until the EIS shares are disposed of, and it will be charged at the applicable CGT rate at that later time. This means that gains deferred that would have qualified for taper relief will not get that benefit when the gain crystallises in future. However, entrepreneurs' relief may be available instead.
Other issues
The qualifying conditions for EIS must be maintained for a three-year period from the date of issue of the shares or the start of trading, if later to prevent a clawback of relief.
There must be no arrangements at the beginning of this period for the company to become quoted during the three year period.
In the next article, I look at VCTs in more detail plus consider whether or not these schemes are worth investing in.
More on tax from Sam Thewlis:
