For a long time, investors have been managing risk by distributing their eggs amongst numerous baskets, in order to build diverse investment portfolios. Since the government introduced the Enterprise Investment Scheme (EIS) in 1994, it has become even easier for investors to manage the risk on their investments. The EIS scheme offers investors the opportunity to engage with potentially very lucrative investments, whilst still retaining an acceptable degree of damage limitation over their cash.
In simple terms, the scheme works by incentivizing individuals to invest in up-and-coming UK businesses who are not registered on the stock market, and thus who generally pose a higher risk to investors. These incentives are tax related, whereby the government withholds many of the usual tax obligations in order to allow investors a more attractive risk-to-gain ratio on their investment.
With this in mind, here’s the 7 most important things investors need to know about the government EIS scheme.
- Benefit from Tax Relief on EIS Investments
Even if you know very little about the EIS scheme it is likely you will have heard about the promise of a 30% tax-relief on all EIS investments up to £1 000, 000. This means that if you were to invest £50,000 in an EIS investment, you could enjoy tax-relief on £15,000 of your investment.
In order to benefit from the tax relief clause, you should retain your EIS 3 certificate and provide this to HMRC when filling in your self-assessment tax return.
- Enjoy Exemption from Capital Gains Tax
As long as you retain your EIS investment for at least three years, any profit you make after disposing of your investment will be exempt from Capital Gains Tax (CGT). Capital Gains Tax rates can vary from 18% to 28% (typically payable after an initial Capital Gains allowance of £11,000), so the potential saving from this exemption is significant.
Many of the EIS shares do make significant, stable profit over time and so investing in the right one over a period of 20 years, whilst being exempt from any CGT, could result in a very lucrative capital gain.
- Offset your Losses if it all goes Wrong
Perhaps one of the most attractive aspects of the EIS scheme is the ‘loss relief’ that it offers. Firstly, you are able to minus the 30% of tax-relief allowance from your capital loss, as the government effectively agree to be liable for 30% of your investment when you invest in the scheme. Secondly, you are able to offset a proportion of remainder against your tax bracket for that year.
So, for example: If your capital investment of £50,000 suddenly became worthless – you could minus £15,000 from the capital loss (30% tax relief), leaving you with £35,000 of capital at risk. Furthermore, assuming you’re in the 45% tax bracket, you could then offset the £35,000 of capital against your loss relief allowance, meaning that your actual loss would be £19,250, rather than £50,000. As such, risk of catastrophic loss is managed fairly well in an EIS investment.
As already suggested, the most sensible investors are likely to spread their cash over a wide variety of different investment projects. As such, it is not advisable to invest all of your funds in EIS investment opportunities, as even though the risks are managed, they could still result in substantial losses.
- Backdate the Benefits to the Previous Tax Year
Another great benefit of this scheme is that the investment can be treated as if it were acquired in a previous tax year. As such, the tax relief of 30% can be backdated to a previous year.
- Be Aware of the Restrictions
There are numerous important restrictions which you should be aware of before taking out an EIS investment. Some of the important ones being that – you cannot hold more than 30% of the company’s shares you are investing in, and you also must not be employed by, or have any connection of interest with, the company whose shares you are investing in. The other crucial thing to remember is that you must hold the shares for a minimum of three years to take advantage of any of the tax related benefits. If you do not adhere to the three year rule then tax relief will be withdrawn, and this withdrawal backdated where applicable.
- Tax Inheritance Relief
EIS investments are also completely exempt from inheritance tax after a period of two years, so long as the investor still owns the investment at the time of death. Seen as almost every asset or investment is liable to inheritance tax, this exemption is a noteworthy perk of EIS investments.
- Decide Whether to Invest Directly or via a Fund
EIS investment funds allow investors to place their investment in various small businesses, whereas a direct investment will involve devoting the funds to just one business. There are clearly positives and negatives to both of these choices. However, investing via a fund may be a further way of managing risk for the more cautious investor, as investing via a fund does seem to align with the more general tendency for investors to build a wide-ranging and diverse investment portfolio.
Although this article has tried to cover all the important aspects of EIS investments, it is important to fully research all of your options so you can make an informed decision about whether an EIS investment is right for you. A good place to find more detailed information is on the HMRC website. If you have decided that you want to take advantage of the tax related benefits that come with EIS investments then the next step is to decide exactly how, and with who, you are going to invest your funds.
On balance, EIS investments seem to have a two-fold benefit. Not only are they likely to continue providing a much needed boost to the UK economy, but they also appear to provide a unique investment opportunity for British investors; investment which has good lucrative potential backed up by a significant degree of damage limitation.