Enterprise Investment Schemes are a relatively new type of investment introduced by the Government to encourage investment into smaller companies, who need additional finance, often for start up capital or to expand the business.

The reason behind this is that the companies are relatively small and are often start up companies. This means that frequently these investments are in a higher risk bracket than ordinary investments into equities.

To encourage investment into these companies, major tax incentives and benefits were introduced with the investments:

Capital Gains Deferral

Investors are able to defer unlimited capital gains made elsewhere by subscribing for shares in an EIS qualifying issue. Investment into the EIS must be made up to one year before or up to three years after the capital gain was made. The capital gain is ‘re-crystallised’ on disposal of the investment or if the company ceases to be qualifying.

 Income Tax Relief

Income Tax Relief is available at the rate of 20% on investments of up to £400,000 in any tax year. This is up to a maximum of £80,000 income tax relief each tax year. It is important to note the following:

An investor cannot however receive tax relief of more than they have paid in the relevant tax year.

As long as 3 years from the purchase of the shares or commencement of trade, whichever is the latter, the shares have remained qualifying and been retained by the individual. If within 3 years the shares cease to be qualifying or the asset is disposed of wholly or in part then the Income Tax Relief claimed must be paid back wholly or in part to HM Revenue & Customs.

• In the period from 6th April to 5th October, it is possible to treat up to 50% of each investment and no more than £50,000 in aggregate as being invested in the previous tax year.
• An individual does not need to be a UK resident, but must be a UK taxpayer.
• An individual cannot be connected with the company either as an employee, an existing paid director or a holder of more than 30% of the existing share capital or voting rights.

Capital Gains Tax Exemption

Any profits arising on disposal of EIS qualifying shares are exempt from Capital Gains Tax, provided the shares have been held by the individual and remained qualifying for the 3 year period since purchase or commencement of trade, whichever is the latter.

The limitations or conditions are broadly similar to the above conditions to qualify for Income Tax Relief.

Loss Relief

If EIS qualifying shares are sold at a loss then loss relief is available on the net loss at the investor’s marginal rate of tax. The net loss is the original sum invested less any initial Income Tax Relief claimed less the value received on disposal. Losses made by individuals can be offset against capital gains in the year of loss or a future year or against income in the year of the loss or the previous year. Trustees are only able to offset losses against capital gains.

Business Property Relief

Where on death there is a chargeable transfer for IHT purposes of qualifying shares which have been held for 2 or more years prior to the death, business property relief may reduce the value of the transfer to nil for IHT purposes.

This also applies to lifetime transfer of qualifying shares, such as a Potentially Exempt Transfer, which becomes chargeable on death if it was made within the last 7 years, or a chargeable transfer into a discretionary trust. For this treatment to apply it is necessary for the transferee to hold the shares originally gifted or, subject to certain conditions, replacement qualifying shares, at the date of death.

EIS Portfolio / Risk Management

Like any investment considered as part of a clients investment portfolio, the advantages and disadvantages should be weighed up as well as considering if the investment can assist in reaching your investment goals.

Many companies have now introduced EIS portfolio management products. These products invest the client’s monies into a carefully selected group of qualifying EIS investments which spread the risk and gives the client more exposure to a varied selection of stock whilst allowing all the tax advantages to be utilised.

An EIS is a high-risk investment. Please bear in mind the following risk warnings are designed to draw your attention to the particular risks involved with investments in Enterprise Investment Schemes:

The value of shares in EIS can go down as well as up. Although EIS are quoted on the stock exchange, a large proportion of the EIS capital must be invested in unquoted securities. It is likely therefore that EIS shares will trade at a substantial discount to the Net Asset Value (NAV) until the liquidation strategy is invoked and you may find it difficult to realise the true value of the investment in this interim period.

Income tax relief is granted at the rate of 20% on subscriptions for new EIS shares up to an invested amount of £400,000. However, the Inland Revenue will reclaim this tax relief if the shares are not held for at least three years or if the EIS is deemed by the Inland Revenue to lose its qualifying status.

In addition, if you have taken advantage of the CGT deferral service there is a possibility of the crystallised gain becoming payable by your estate should you die before all of the invested monies are invested in qualifying shares.

There is no right of cancellation once the investment is processed, nor does the Financial Services Compensation Scheme apply.

EIS investments are not regulated by the FSA, therefore normal investor protection arrangements do not apply.

All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and Inland Revenue practice. Levels and bases of, and reliefs from, taxation are subject to change.