The Enterprise Investment Scheme (EIS) was launched in 1994 by the UK government as a way to encourage investment in small UK companies. EIS is a series of tax reliefs which benefit investors when they invest in eligible start-ups or early-stage businesses. In turn, the scheme benefits small businesses by turning them into more attractive investment opportunities (by reducing potential investor losses), making it easier for them to acquire the investment they need to grow.
Investing in small or new businesses is often a risky venture. Companies that are not listed on a stock exchange hold a particularly high risk of losing capital. Not only that, small companies typically take a long time to earn back investment or generate any profit. EIS, therefore, provides investors with attractive benefits to counterbalance the risks associated with supporting fledgling businesses.
By encouraging more investment, the scheme has significantly supported and boosted entrepreneurial activity in the UK. These types of business tax reliefs have a huge array of benefits for investors, making the UK the perfect location to not only start a business but to expand one as well.
What is EIS?
The Enterprise Investment Scheme offers several different forms of tax relief to investors who invest money into eligible companies. Briefly, EIS offers tax benefits in the following ways:
- 30% relief on Income
- Exemption from CGT on any gains after three years from the investment
- Capital Gains Tax deferral when gains are reinvested in other EIS eligible companies
- Loss relief when EIS shares are disposed of at a loss, either by being set against the investor’s capital gains or set against the income tax bill in the year of disposal
- Carry-back: applying tax relief to a previous year
- Reduction or elimination of Inheritance Tax on eligible EIS shares held for two years.
Two options for EIS investment
There are two options for investing with EIS. Either, you can invest directly in an EIS qualifying company, or you can invest in an EIS fund. Investing directly into a single company allows the investor greater transparency and therefore, control in the investment opportunity. However, it is usually a riskier venture as your investment relies on the success of that company specifically.
Alternatively, it is possible to invest through a fund manager. A fund manager will build you an EIS investment portfolio, choosing in which companies you invest. The benefit of a professional fund manager is that they will be doing constant research for you to make your investment decisions. However, this can also be the main drawback of this option: you have less control over your investment. Such professional managers are also not low cost, making this option a more expensive venture.
As shares eligible for EIS are not listed on the stock market, investors looking to not directly invest typically invest through a specialist broker or through an EIS fund.
EIS rules
EIS is a complex scheme. Each branch of EIS tax relief carries its specific requirements, along with the standard stipulations. The following rules apply to any claim for EIS:
- In each tax year, you may only invest a maximum of £1 million in qualifying companies (the number of qualifying companies is not limited)
- The investor must hold the shares for at least three years
- The investor may not carry-forward their EIS tax relief
- The claimant must be a UK taxpayer
- The investor must not be connected to the EIS company, either as an employee, partner, or remunerated director
- The shares must be paid for in full, in cash, by the date of issue
- The shares bought by the investor must be new shares which are not on the market.
Are you eligible for EIS?
After adhering to the above rules, both the company and investor must fulfil certain additional conditions to benefit from any of the tax reliefs under EIS. EIS is one of the more complex tax benefit options available. Before you think about applying, check that you meet the requirements, either as a company looking to attract an investor under the EIS scheme or as an investor hoping to profit from tax benefits.
Investor
If you are an investor, you must satisfy the following requirements to qualify for EIS:
- Your interest in the company must be no more than 30%
- You must not be an employee, partner or ‘paid director’ of the company
- No partner or associate of yours may have interests in the company (including your spouse, relatives or previous business contacts)
- You must not have any form of preferential shares
- You must not have any form of controlling interest in the company
- You must not be using the scheme as a form of tax avoidance.
There is one exemption to the rule disqualifying connected persons employed in the company. This exemption aims to encourage investment from business angels in the scheme, despite their roles as directors of the company. Business angels may still qualify for tax relief despite being paid for their services, provided that the angel director was not connected to the company at the time of issue of the shares. The rules for business angels are strict, however, so its advisable to seek advice from HMRC.
Company
For an investor to be able to claim EIS, the company they are investing in must meet the EIS eligibility requirements and maintain their EIS eligible status for the duration of the shareholding. To be considered an EIS eligible company, the following conditions must be met:
- the company must have a permanent establishment in the UK
- the company must not be listed on a recognised stock exchange, or plan to be listed, at the time of issuing shares
- the company must not have control over another company, except any qualifying subsidiaries
- no other company may have control of the qualifying company or have 50% or more of its shares
- the company does not expect to close
- the qualifying company and any of its subsidiaries must not have gross assets which exceed more than £15 million in value before any shares are issued, and not more than £16 million immediately after
- the company must have less than 250 full-time employees at the date of issue of the shares.
In addition to these conditions, the investment must be used for a qualifying trade. Most business activities are acceptable, but some of the excluded trades are listed below. Should these excluded trades represent over 20% of the business’ daily activities, this would render the company ineligible for the scheme. Examples of excluded activities are:
- Coal or steel production
- Farming or market gardening
- Forestry
- Legal or financial services, including banking and insurance
- Property development or leasing
- Production of fuel
- Energy generation
- Exporting electricity
- Operating hotels or care homes
- Providing services to a non-qualifying business
- Dealing in futures or securities.
HMRC will evaluate your daily business activities to determine whether your company fulfils the qualifying trade requirement. If your company deals in any of the excluded trades above, you should consider seeking advice from HMRC on your eligibility for the scheme. You can do this by seeking ‘advance assurance’.
Advance Assurance
If you are unsure whether your share issue is likely to qualify for the scheme, you can ask HMRC directly. This is what’s known as ‘advance assurance’, where HMRC will give you their verdict on whether they feel you are eligible to make a claim. However, while HMRC may agree that you are likely to qualify for EIS, it is only an opinion and by no means a guarantee. It can be useful, however, to show investors as an investment incentive.
How does EIS work?
Under the Enterprise Investment Scheme, there are several tax benefits available to investors and qualifying companies. The list provided at the beginning of this post summarised the six main guises of EIS. We’ll now take a closer look at each of these tax reliefs, how they work and at the qualifying conditions specific to each form.
Income Tax relief
One of the main tax reliefs offered under EIS is income tax relief. Investors can claim 30% of their initial investment back as income tax relief. The relief works by reducing the investor’s income tax bill, knocking off an amount equivalent to 30% of the EIS eligible investment.
For example, if you invest £100,000 in a company which is eligible for EIS, you can claim £30,000 back in income tax relief in the year you made your investment. With an annual £1 million limit per investor, this means that you can knock up to £300,000 off your income tax bill!
Capital Gains Tax exemption
All financial gains above £6,000 (with the main exceptions being your car or your main home) are subject to Capital Gains Tax. CGT is a tax on the profits you make from selling any assets. The amount you pay is determined by your tax band and can be anywhere from 10% to 28%. Most investors will be looking at paying at least 20% CGT on their gains.
EIS offers CGT exemption on any gains made from invested shares. Provided that the shares are held for at least three years after investment, any gains made on these shares may be exempt from Capital Gains Tax under this scheme. This means that if you invested £10,000 in EIS shares and then decide to sell them after three years for £40,000, you can pocket the full £30,000 profit without paying any Capital Gains Tax. In this example, you’d have saved £8,400.
Sound too good to be true? In some cases, it is: do be aware that start-up equity is considered a high-risk asset class. In other words, you may well sell your shares at a loss, making CGT exemption irrelevant.
Capital Gains Tax deferral
EIS offers a second relief affecting Capital Gains Tax. This relief allows investors to defer paying Capital Gains Tax on any asset if the gain from the disposal of that asset is used to invest in shares in another EIS qualifying company. As such, CGT deferral aims to encourage further investment under the EIS scheme.
To be eligible for CGT deferral, gains from the disposal of EIS shares must have been made within the twelve months before the EIS investment or within three years after. The relief is limited to the amount invested in the EIS company.
EIS loss relief
Investments are risky by nature. Investing in early-stage start-ups runs a particularly high risk. This risk is made far more appealing through the availability of loss relief for EIS investors. This form of relief can reduce the impact of losses made on investing in EIS companies.
By claiming loss relief, investors can offset any losses made on an EIS company with two possible options. The investor may either offset the loss against their income tax bill or their capital gains tax bill.
To qualify for loss relief, the value of an investment at the point of sale must be less than what is known as its effective cost. The effective cost is the sum invested less whatever the investor has previously claimed in income tax relief.
Calculating loss relief against income
The amount you can offset against any income tax bill is calculated by multiplying the value of the effective loss by the investor’s marginal rate of income tax. The effective loss is the effective cost, minus the sale price.
To give you an example: for an investment with an effective cost of £15,000, which is later sold for £5,000, the effective loss would be £10,000. Assuming the additional rate of marginal tax is 45%, which is the amount applicable to most investors, the amount the investor can claim as loss relief is £10,000 x 45%, which gives £4,500 of tax relief.
Calculating loss relief against CGT
For some investors, it is more tax-efficient to offset their loss against their Capital Gains Tax bill instead. To work out the available tax relief for this route, you multiply the effective loss (as above, the effective cost less the sale price) by your CGT rate. For EIS shares bought for an effective cost of £18,000 and later sold for £3,000, the effective loss equates to £15,000. With a CGT rate of 28%, the loss relief available would be £4,200!
Loss relief works on a company-by-company basis. This means that even if an investor has shares in multiple EIS companies which have provided a net profit, they may still claim loss relief if one individual company has not returned the initial investment.
Similarly, however, even if an investor claims loss relief, they may still make a net loss. While loss relief will always reduce the impact of a loss, it will not necessarily prevent a loss.
To claim for loss relief, you need to complete the SA108 form as part of your self-assessment tax return. You can find this form on the HMRC website.
For every rule…
There is one notable exception from EIS loss relief. If the EIS shares are inherited, the beneficiary is not permitted to claim loss relief when they dispose of these shares. HMRC treat inherited shares, known as secondary shares, as acquired by the inheriting party at their market value at the time of death of the donor.
Carry-back rule
EIS offers a carry-back rule, whereby shares can be treated as issued in the previous tax year, provided that the EIS relief limit is not exceeded for that year. Therefore, should you put £500,000 into an EIS eligible company in the 2018/19 tax year, you could choose to carry-back the £150,000 tax relief (30% of £500,000) to be set against your 2017/18 income tax bill.
This tax benefit also means that investors can exceed their £1 million annual limit. Investors may invest up to £2 million in one tax year without exceeding their yearly cap by carrying back £1 million to the preceding tax year!
Do note that while tax relief may be carried back a year, it may not be carried forward.
Inheritance Tax relief
After two years of holding EIS shares, it is possible to claim inheritance tax relief of up to 100%. This benefit is only applicable if the shares are not listed on a recognised stock exchange.
Maximising benefits under the EIS
The Enterprise Investment Scheme allows qualifying investors to take advantage of as many of these tax reliefs as are applicable under their circumstances. Investors can, therefore, qualify for several of the above tax benefits in the same investment opportunity. The following examples demonstrate how investors can benefit from multiple tax reliefs within the scheme.
Example 1
Mrs Grahame is an angel investor who meets the investor qualifying conditions to gain tax benefits under EIS. She invests £30,000 into an EIS eligible start-up. After three years, the business has performed well, doubling the value of her shares to £60,000. At this point, she disposes of her shares.
First off, Mrs Grahame can claim income tax relief equal to £18,000, which represents 30% of her initial investment. When she comes to dispose of her shares three years after the date of issue, she is exempt from Capital Gains Tax, meaning that she can keep the entirety of her investment returns.
In this example, Mrs Grahame can claim income tax relief as well as profiting from CGT exemption. Her total savings from this investment equals £46,000 under the Enterprise Investment scheme!
Example 2
Mr Singh invested £30,000 into an early-stage business. Both Mr Singh and the issuing company meet the respective EIS qualifying conditions. Three years later, the business remains the same value as at the date of issue. At this point, Mr Singh decides to sell his shares.
In this example, Mr Singh is also exempt from paying CGT on the sale of his shares, meaning he has broken even after his investment. However, he is also eligible to claim income tax relief of £9,000, representing 30% of his initial £30,000 investment. In this example, despite the business not increasing in value, Mr Singh has still made a £9,000 gain on his investment, thanks to EIS.
Example 3
Ms Littlewood invests £10,000 into an EIS eligible company. The company fails, meaning her shares hold no value after three years.
In the year of investment, Ms Littlewood claimed £3,000 in income tax relief. The effective cost of her investment, therefore, equates to £7,000 (£10,000 less £3,000). As the value of the shares is now zero, she is eligible to claim for loss relief. Assuming she pays income tax at 45%, she can claim £3,150 in loss relief.
In this example, Ms Littlewood has claimed back £6,150 of her investment via income tax relief and loss relief, meaning she’s reduced her net loss to £3,850.
As demonstrated in these examples, investors can not only enjoy huge benefits but may also mitigate their losses significantly under the tax reliefs offered by the Enterprise Investment Scheme. It is no wonder, then, that the EIS scheme has generated over £15 billion of private capital since its introduction in 1994!
What can companies use EIS investment for?
The Finance Bill in 2018 contained several changes which impacted the EIS and what EIS investments can be used for.
The risk to capital condition
The main change in the 2018 bill was an additional eligibility condition (risk to capital condition) which is now essential to securing EIS tax benefits. Prior to 2018, there was concern that the EIS was being used to preserve capital in low-risk investments.
In many cases, money was being invested in start-up ventures offering a secure return, either in the way of insurance from asset-backed investment or opportunities where contracts existed for the duration of the project. This security minimises the risk to investment capital.
To prevent EIS from being used for low-risk capital preservation, the new condition ensures that there is a substantial risk to the investment. Such risk ensures that an investor’s primary intention is to support the business, rather than being to secure tax benefits.
This addition is called the ‘risk to capital condition’ and comprises two main factors. The first states that the money raised by EIS must be used by the issuing company to grow or develop its business in the long-term. Growth or development refers to increasing revenue, growing a client base or increasing the size of the workforce.
Secondly, the investment must represent a significant risk to the investor’s capital. In other words, it must be plausible that the investor could lose more money than they could gain as net return from the investment. The net return estimates the income from dividends and interest, capital growth and upfront tax relief.
HMRC considers several aspects to determine whether a company meets the risk to capital condition, such as:
- Sources of income or asset backing
- Structure
- Use of subcontractors
- Promotion of the investment opportunity.
HMRC will evaluate these factors to consider to what extent the return of capital is guaranteed and whether the investment subsequently satisfies the risk to capital condition.
How do you claim for EIS?
As an investor, you will usually claim EIS tax relief when filling out your tax return. If the shares you purchased were EIS eligible, you would have received an EIS3 or EIS5 certificate from the issuing company. This document certifies that the shares are EIS qualifying shares and subsequently that the issuing company qualifies under the scheme as well.
EIS3 or EIS5?
The form EIS3 is entitled ‘Enterprise Investment Scheme Certificate and claim to relief’. This form is issued by the company in which you invested. It certifies that the relevant conditions of the scheme are satisfied by the issuing company.
In one case, you may not receive an EIS3 as an investor and may instead receive the EIS5, ‘Certificate and claim to relief for investment through an approved fund’. This situation occurs if the investment was made through an approved investment fund. In this case, the fund manager will receive the EIS3 and in turn, issue an EIS5 form to the investor. This form may be used in the same way as the EIS3 to claim tax relief under the scheme.
Where to claim?
In your Self-Assessment tax return, you will be provided with supplementary pages SA101 which is where you should give details of your EIS share disposal and the EIS tax reliefs for which you wish to claim.
In this form, you will first have to give the total amount of subscriptions on which you’re trying to claim relief. Remember that this figure cannot exceed £1 million. It can exclude any amounts for which you’re claiming carry-back tax relief, as you’ll need a different form for these for the previous tax year.
In addition to the total you wish to claim on, you will have to provide details of each investment you made. Information you need to provide includes the name of the issuing company, the total amount on which you can claim relief, the date of issue of the shares and the name and reference of the HMRC office which authorised the EIS3 certificate.
HMRC may request evidence of the EIS3 certificates at any time, so these should be kept safe. Note that you may not claim for relief under the Enterprise Investment Scheme without an EIS certificate, regardless of whether this is due to you or not. Only once you’ve received your certificate may you make a claim.
No certificate, no claim
Should you receive your EIS3 or EIS5 certificate after you’ve completed your tax return, you may still make a claim. The EIS3 or EIS5 will include a claim form. Simply complete the form and return it to HMRC to make a claim after submitting your tax return.
Claiming for tax relief in the previous year
To claim for EIS relief in the previous tax year for which you’ve already completed a tax return, fill out the claim form enclosed in the EIS3 or EIS5 certificate.
If you’re completing a tax return for the previous year, you can claim for it in the tax return as usual. You must include the amounts invested in that tax year for which you wish to claim as well as any amounts invested in the current tax year, which you want to claim relief for in the previous year.
Making a claim when you pay tax via PAYE
If you pay tax via PAYE and do not usually fill out a Self-Assessment tax return, you should use the claim form on pages 3 and 4 of the EIS3 or EIS5. You will then also need to fill out all the details of the investment when filing your tax return.
Claiming for jointly owned shares
In the case of shares issued to joint owners, the shares are treated as though each owner had subscribed an equal amount for an identical number of shares. For example, in the case of a married couple subscribing £2,000 for 2,000 shares, each partner is considered to have subscribed £1,000 for 2,000 shares. This assumption applies even if one of the partners paid the full amount. Each partner should receive an EIS3 form for their subscription.
When must a claim be submitted?
From the 31 January following the tax year in which the shares were issued, you have up to five years to claim EIS tax relief.
Are there limits to EIS investment?
Companies can get up to £5 million in EIS investment per year, up to a maximum of £12 million in the company’s lifetime. This limit includes investment received under other venture capital schemes. Funds raised from the following sources contribute to these limits:
- EIS
- Venture Capital Trusts (VCT)
- SEIS (Seed Enterprise Investment Scheme)
- Social investment tax relief
- State aid
Companies can receive investment under EIS provided the investment comes within seven years from the date of the company’s first commercial sale. In the case of businesses with subsidiaries or acquired businesses, the date of the first commercial sale applies to the earliest commercial sale from any of these connected companies.
An exception to the seven-year period
If you did not receive investment within the first seven years, you might still be eligible for EIS. You must be able to prove, however, that the money is necessary to enter a new, unconnected product market, or a new geographical market. You’ll also have to show that the money you’re hoping to procure equates to at least 50% of your company’s average annual turnover.
Limits also apply to investors. Individual investors may claim relief on up to £1 million of investments in qualifying companies per year. In some cases, investors can apply their EIS investments to the previous tax year under the carry-back option.
Extended limits for KIC investments
Where investments are made in knowledge-intensive companies (KICs), the limits increase. Individuals may invest up to £2 million provided that £1 million is invested in knowledge-intensive businesses, doubling their annual restriction. HMRC defines knowledge-intensive companies as any companies which carry out research, development or innovation. They must have KIC status at the time of issuing shares for this increased limit to apply.
KICs are also allowed to raise double the amount of funds of other eligible businesses, taking their yearly cap up to £10 million. The employee limit is also doubled, allowing any number up to 500 rather than 250. Finally, KICs benefit from an extended investing period: ten years rather than the standard seven.
If a company owns subsidiaries, is it EIS eligible?
Companies may still be EIS eligible when they own subsidiaries. They must, however, be ‘qualifying subsidiaries’. To qualify, they must meet the following requirements:
- your company must own more than half of the subsidiary’s shares
- this subsidiary may only be controlled by your company or another of its qualifying subsidiaries
As well as this, the subsidiaries must also have fewer than 250 full-time employees, and their gross assets must not exceed £15 million in value.
It is important to note that any funding that any qualifying subsidiary companies have received under the EIS scheme counts towards the £5 million annual limit for EIS as well as the £12 million lifetime limit.
The future of the Enterprise Investment Scheme
As of April 2020, there will be a number of changes to the EIS fund structure. The 2018 Budget included amendments to the ‘approved’ EIS fund structure to take effect from April 2020. The changes will focus approved funds on knowledge-intensive investments, introducing a requirement stipulating that 80% of raised funds must be invested into knowledge-intensive companies.
Secondly, the changes aim to increase flexibility for fund managers in the timing of investments by extending the time period in which they must make investments from one year to two.
Schemes such as the Enterprise Investment Scheme are constantly evolving. It is important to keep up to date with HMRC guidelines on the EIS as well as government advice on claiming tax relief.
What about SEIS?
You may have heard of the Seed Enterprise Investment Scheme (SEIS). As the younger sister of EIS, the two are, for the most part, very similar. Both schemes were introduced to encourage early-stage investment into small and new UK companies.
SEIS, however, is specifically aimed at start-ups and even younger, newer companies. SEIS applies specifically to start-ups seeking funding at their inception. The tax reliefs they offer differ slightly, with a greater incentive for SEIS investors concerning income tax relief. The qualifying conditions also differ to target smaller businesses.
To EIS or not to EIS
EIS is undoubtedly one of the most attractive tax benefit initiatives introduced to the UK. The rewards are wide and varied, and the possibility to claim multiple reliefs makes it a very attractive option for potential investors.
However, the scheme aims to incentivise investment into early-stage businesses for a reason: they are naturally very risky investment opportunities. Investing in young and new enterprises runs a huge financial risk, which means that investors should have enough capital to be able to withstand potential losses.
Not only this, but the EIS requires long-term investments. The minimum shareholding requirement of three years means that the scheme is only appropriate for sophisticated investors who do not require immediate liquidation of assets.
Finally, EIS investments are also harder to sell as no recognised market exists for EIS eligible shares. All these factors mean that while the EIS is an attractive scheme, it is a complex one which is only suitable for high net worth experienced investors.
