Enterprise Investment Schemes

George Osborne has previously stated that he wants to make the UK the 'best place in Europe to start, finance and grow a business’. But with the banks unable, or unwilling, to make loans to new businesses, alternative sources of finance raising have been sought.

The Enterprise Investment Scheme (EIS) aims to fill the gap by helping smaller, higher-risk, trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.

EIS managers typically seek to raise between £10m and £30m of venture capital from a pool of individual investors. The EIS manager will then invest the money, over time, in a portfolio of between five and 10 companies, which may be spread across multiple industry sectors or invested within a single sector, such as Entertainment or Green technology. This provides investors with the opportunity to invest in new business ventures and also benefit from the attractive tax reliefs available.

EIS investments are subject to stringent investment criteria but are one of the most tax efficient investment products available to UK investors, as shown below:

• Income tax relief at 30% on investments up to £1m
• Must be held for three years or income tax relief clawed back pro rata
• No clawback on death
• Tax free capital distributions (dividends subject to income tax)
• Can carry back tax relief to previous tax year
• Capital Gains Tax deferral relief – one year before and three years after the capital gains arise (loss relief also available)
• Possible to benefit from 100% relief from IHT if held for two years

You may be wondering why the tax benefits are so generous? This is partly answered by explaining that the investment of EIS funds into unquoted or AIM listed companies leaves them at the higher end of the risk spectrum. As mentioned above, The Government wishes to encourage investment into new and fledgling UK companies and offers such generous tax benefits to compensate investors for this additional risk.

Any individual who:

• Is retired and can no longer benefit fully from pensions tax relief
• Has significant income tax liabilities and would benefit from receiving 30% income tax relief
• Wishes to receive gains upon disposal of the shares tax free
• Wishes to move monies out of their estate into an IHT free environment
• Has the appropriate risk profile for investing in such a higher risk investment.

All in all, it hardly seems fair that pensioners are still required to pay income tax on their pensions if their income exceeds their personal allowance, but thousands of retirees find themselves in this position.

Additionally, in a move that will affect nearly four and a half million people, the Government will freeze the old age personal allowance (the amount you can earn tax free) from April 2013, and then scrap it altogether for anyone turning 65 after 5 April 2013. This represents an effective stealth tax charge. An investment into an EIS could enable anyone affected to reclaim lost relief.

Income tax relief is also easy to claim, via an adjustment to your tax code – making it a very simple and effective way to access the income tax relief available.

Anyone keen to reduce their income tax bill for last tax year, investing in an EIS enables them to elect to ‘carry back’ to the 2011/2012 tax year, investments up to £500,000 and receive income tax relief of up to 20% of their investment.

If you have a second property and are expecting to make a capital gain, an investment into an EIS offers the opportunity to defer the gain. For example, if your capital gain upon sale of the property is £100,000, you will be required to pay capital gains tax (CGT) of at least £28,000 on the gain (assuming no annual exemption available). But by investing into an EIS, you will defer the CGT payable in the year of disposal until a later year and benefit from £30,000 income tax relief.

The deferred capital gain of £100,000 will be brought back into charge whenever the shares are disposed of – the benefit is primarily a timing benefit, subject to changes in CGT rates.

As mentioned earlier, an EIS can be an illiquid, higher risk investment, but the tax benefits available are appealing. As always, the tax advantages should not outweigh the investment considerations but most EIS schemes do offer risk mitigation to protect against any potential downside. It is therefore important that you seek independent financial advice before making any such investment.