Fears that concerns over the misuse of the Enterprise Investment Scheme (EIS) would lead to it being cut back on or scrapped altogether when the 2017 Budget was announced yesterday were proven to be misplaced. Instead, Chancellor Phillip Hammond announced that the maximum value of EIS investments that could take advantage of tax breaks is set to be doubled to £2 million from the present £1 million. However, it was also announced rules around companies that qualify for the scheme would be tightened.
Overall, at least for genuine EIS investors, yesterday’s announcement was a massive boost. The Enterprise Investment Scheme was first established over 20 years ago now as a means to help smaller unquoted companies raise investment capital. Investors in companies that have applied for an been accepted as EIS-eligible are able to initially reclaim up to 30% of capital invested up to £1 million per annum in tax relief, though shares must then be held for at least 3 years.
This tax relief can even be ‘carried back’ to the previous year if the amount of tax the investor has paid in the year shares are acquired is not enough to use the entire 30% tax relief awarded. Any future loss on the sale of the shares, at least 3 years after acquisition, can also be offset against income earned that year. Capital gains tax on other investment gains can also be offset if invested in an EIS-eligible company up to one year before and three years after the gain has been realised.
Altogether, the different tax breaks that come with investing in an EIS company mean that up to 70% of the total sum invested can be tax deductible, if shares are sold at a lost. This makes a huge contribution to reducing the risk profile of this kind of investment and has encouraged significant volumes of private investment capital into EIS companies over the years. The changes announced yesterday are expected to mean an extra £7 billion ok investment flows into young UK-based enterprises with 4000 investors a year benefiting.
Concerns have been raised that EIS has been widely misused. The scheme is designed to help high risk profile young businesses raise enough capital to reach a significant growth stage, where revenues will then mean they are self-supporting. However, ‘firms’ with low risk activities focused on ‘capital preservation’ were being set up specifically to take advantage of EIS tax breaks. Investment in these vehicles by high net worth and sometimes high-profile individuals has been caught up in numerous tax avoidance scandals in recent years.
However, with a significant Budget focus on replacing lost European Investment Bank funds available to young companies and keeping investment UK at the ‘forefront of the technology revolution’, EIS has not proven to be the victim many expected. How successful the Government will be in their attempts to correctly bracket EIS-eligible companies as “knowledge intensive” and excluded “low risk” companies remains to be seen. The UK investment community has, however, responded positively to yesterday’s news.
Quoted in the Financial Times, Alex Alex Davies, chief executive and founder of Wealth Club, an EIS-focused broker, commented:
“Unexpectedly, this has been a very good Budget for VCT and EIS investors. It rewards entrepreneurial companies and investors who are prepared to take some risk to support British business. Whilst there will be restrictions on some capital preservation focused products, investments made in the spirit of EIS will benefit burgeoning business and their investors. “With all the changes to pensions beginning to bite this type of investment is only going to grow in popularity.”
Venture Capital Trusts have also benefited as the amount that can be invested into young companies by these tax efficient structures has also been lifted from £5 million to £10 million.