The tax reliefs available under the EIS are not considered to be avoidance of tax. Therefore they need to be carefully considered if you wish to relieve capital gains tax or income tax.
Enterprise Investment Schemes (EIS), are tax efficient schemes for investing in small businesses. Smaller companies often find it difficult raising capital. To assist businesses to expand and encourage private investors to invest, the government introduced generous tax incentives in exchange for locking investors in for a minimum of 3 years. Although we would always advise that you allow for a longer time frame for investing in an EIS.
An EIS can be as simple as a single company investment or it could be a number of companies wrapped up in an EIS fund. However the investment is made, it is ultimately an investment into one (or a number) of small unquoted businesses.
Neither single company EIS or managed EIS services are traded on a stock exchange so liquidity is poor and withdrawing cash early can be difficult. Some advisers will state that EIS’s should only be considered by sophisticated investors. This is not necessarily true however, as the tax advantages and financial planning advantages are such that they should be considered for clients engaged in sophisticated tax planning.
Relief is currently available from income tax, capital gains tax and inheritance tax, but like all tax legislation – rules can change. The potential tax savings should be considered and the full risks and potential rewards of an EIS investment should be understood.
Income tax rebate of 30% is available on investments up to £500,000 per tax year, providing you’ve paid sufficient income tax and stay invested for three years.
There are two aspects to capital gains tax (CGT) relief available. Growth on the EIS is tax free as long as you have held the investment for at least three years.
Also, you can use an EIS to defer a capital gain and either delay paying CGT or avoid it altogether by ensuring any disposals are within your capital gains tax exemption.
As long as an EIS continues to trade and was held for at least two years at the time of death it falls outside your estate for inheritance tax purposes.
Dividends from EIS companies are paid with a 10% non-reclaimable tax credit and are potentially liable to further tax. Consequently most EIS companies do not pay dividends as it is more tax efficient to roll up income within the company as tax free growth.
For investments up to £500,000 per tax year, and providing sufficient income tax has been paid, a rebate of 30% is available. Therefore up to a maximum of £150,000 can be reclaimed in any one tax year.
Carry back rules
In addition an investor can elect to ‘carry back’ up to £500,000 of the EIS investment to the previous tax year. This means income tax already paid could be reclaimed. It also means up to £1 million could be invested in a single tax year if no investment was made in the previous tax year.
Capital gains tax
There are two aspects to capital gains tax relief. Firstly, any growth on the EIS is free of tax as long as the investment has been held for at least three years.
However, more important is the ability to defer a capital gain into the EIS thus deferring the payment of capital gains tax.
As long as an EIS is held for at least two years, and continues to trade, full relief is given from inheritance tax against the value of the investment; effectively the investment falls outside of an estate for inheritance tax purposes. It is based on the value at the time of death, not the cost of the investment. This obviously assumes the investment is held at the time of death.
Have a question on any aspect of Tax Avoidance, Financial Planning or Inheritance Tax Planning? Contact one of our Financial Planning Consultants, at Pareto Lawrence we offer both Financial and tax planning advice to corporate and private clients.