Higher rate tax relief on pension contributions creates a very tax-efficient savings vehicle. But pensions aren’t only way of making tax-efficient investments. There are a number of alternatives available to investors.
Here is the first of 3 of my favourites.
Enterprise Investment Scheme
The Enterprise Investment Scheme (EIS) was introduced in 1994 to support small companies which struggle to secure finance through traditional channels. Since then, annual investments made through the scheme have grown to more than £1.4bn. In 2014, some 2,600 companies used the scheme to access capital.The EIS provides a range of tax breaks to investors who buy new shares in smaller, higher-risk companies.
You might think that this all sounds quite wide-open in terms of qualification criteria.
Investing in an EIS gives tax haven status without the costs & complexity of moving money offshore.
And you’d probably be justified in thinking that, because there are very few restrictions on the type of company that you can invest in.
As always, the devil is in the detail but in headline terms the EIS-qualifying companies must:
- Not have raised more than £5 million in any 12 month period using any of the government’s investment schemes.
- Not be listed any recognised stock exchange at the time the shares are issued although it can list later without you losing the relief you have. Importantly, the Alternative Investment Market and the PLUS Markets (with the exception of PLUS-listed) are not recognised meaning that you can invest in companies listed on these exchanges and still benefit from the EIS tax breaks.
- Have gross assets of less than £15 immediately before the share issue.
- Have fewer than 250 FTE employees at share issue.
- Carry out an authorised trade.
Essentially, most small companies looking to attract capital investment would be suitable for the scheme.
The purpose of Enterprise Investment Schemes is to recognise that unquoted trading companies can often face considerable difficulties in realising relatively small amounts of share capital
Any shares which you are wanting to use as to claim tax relief must be full risk ordinary shares and must paid up in full, in cash, when they are issued. Failing to pay for your shares at the time of issue is likely to mean that you are not eligible to receive the relief available.
There are some restrictions on who can buy shares. You cannot, for example:
- Be linked to the company either by way of financial involvement or employment.
- Participate in any reciprocal investment arrangements whereby you and someone else would invest in each other’s companies.
- Dispose of your shares within 3 years of purchase without forfeiting any income tax relief you have received.
EIS: One of the few games left in town for anyone wanting to cut their tax bill. #EIS #TaxPlanning
Pros and Cons of the Enterprise Investment Scheme
- Upfront Income Tax relief is available at a flat rate of 30% for investments in an EIS, subject to a maximum investment of £1 million in such shares.
- Capital Gain Tax exemption is provided where you have claimed income tax relief and dispose of the shares at least 3 years after the later of the date they were purchased or the date the company started trading in its authorised trade.
- Capital Gains Tax Deferral is available for anyone who invests their gains in an EIS within 3 years of a gain arising.
- Loss Relief allows you to set any net losses arising out of the sale of your shares against income in the year of, or year prior to disposal.
- It goes without saying that the scheme requires you to invest in small companies that present a relatively high investment risk.
- The 3 year qualification period means your money is likely to be tied up for a long time.
- If the company (operating outside of your control) breaks the scheme rules within 3 years of your investment, tax relief already provided to you will be withdrawn and you will have to pay any tax due.
No amount of tax 'sweetener' can turn a bad investment into a good one. #EIS #investmentrisk
Who should consider investing in an EIS?
If you have a relatively high appetite for risk the Enterprise Investment Scheme may be a good investment option.
[Note: If you’re wondering what your risk score is, take our free Attitude to Risk Survey. It will help you understand whether the EIS is a good fit in terms of risk profile]
EIS investors would typically be making an investment in the company anyway. They are the friends and family of budding entrepreneurs who often lend cash with little expectation of the money being repaid in full. The tax reliefs for “small-scale venture capital” provided through the EIS provide a strong sweetener for these investors.
As I said earlier when talking about the different companies that qualify for participation in an EIS, detailed scheme rules mean that you need to carefully consider investing in this type of scheme.
I advise any clients seriously thinking about whether an EIS might be right for them to contact me. I’d be happy to advise how this scheme would work in your personal circumstances.
I’ll shortly be adding an overview of the Seed Enterprise Investment Scheme to this post. If you take the Attitude to Risk Survey I’ll let you know when the update goes live.