The Enterprise Investment Scheme (EIS) is designed to help smaller, risky businesses raise funding to fuel growth.
Early-stage businesses can find it difficult to secure investment, so the EIS was set up to encourage more investors to back fledgling businesses by offering generous tax-breaks.
To help you see whether the EIS could help you raise funding for your business, we asked award-winning chartered tax adviser, Jonathan Amponsah CTA FCCA to explain how it works.
If I was to say that HMRC wants to help you succeed in business, you would probably think I’m joking right?
Well, not quite.
Let’s say your company has been trading for less than 7 years. It’s growing and expanding. You need some funds to grow and develop it further. You don’t fancy a boxing round with Peter or Debra in the Dragons Den. Neither do you want to approach a bank.
You also know that most investors are reluctant to part with their money without hedging their bets or reducing their risks.
Let’s assume you need to raise £200,000.
What if investors are guaranteed that worst case scenario, they get more than half of their investments back?
And if it all goes well, they will get their investment back plus 30% tax back and not pay a penny in capital gains tax when they sell?
4 Tax Incentives For Investors
Let me introduce you to some of the generous tax reliefs offered by EIS to help you grow your company.
1. Income Tax Refunds – More than 50% of original investment
Let’s say you’re able to raise the £200,000 from an investor called Mark under the EIS scheme.
Mark is a higher rate tax payer who has paid £80,000 income tax from his employment income. He will get £60,000 (30% of his £200,000 investment) income tax refund from the £80,000 already paid. Mark now has only £140,000 of his money at risk (£200,000 less £60,000).
Let’s assume things don’t go well with the investment. Mark gets a second bite of the cherry. He is allowed to claim an income tax loss on the remaining £140,000 (£140,000 x 45% = £63,000).
So out of his original £200,000 Mark now has a total of £123,000 income tax refund back (the original £60,000 + the subsequent £63,000). This represents more than half of his investment (61.5%). Not bad is it?
2. Tax Free Capital Gains for EIS Investors
If Mark sells the EIS shares at a profit, the gains are exempt from capital gain tax. No tax to pay.
And if he makes a loss on EIS shares, Mark also has an option to deduct the loss from any gains he’s made.
3. Capital Gains Tax Deferral for EIS Investors
Let’s assume that Mark sold a buy to let property and made a gain of £50,000. He’s due to pay £10,000 capital gains tax.
If he re-invested the £50,000 in EIS shares, he’s able to defer the £10,000 tax bill until he later sells the EIS shares. Mark gets a cashflow advantage.
4. Inheritance Tax Advantage for EIS Investors
No one likes to talk about death. But it’s a reality. And very often people pay unnecessary inheritance tax by not claiming the right reliefs.
Assuming Mark holds the EIS shares for 2 years. The shares increase in value to £240,000. Mark unfortunately passes away.
His estate is over the IHT taxable threshold, however, the EIS shares should qualify for Business Property Relief. What this means is that beneficiaries of Mark’s estate save £96,000 of inheritance tax (£240,000 x 40%).
Beware of conditions for EIS investors
All tax reliefs come with some strings attached and the Enterprise Investment Scheme is no different.
To qualify for EIS shares, the investor must meet a number of conditions, including;
- Not being connected with the company
- Not holding more than 30% shares and
- Subscribing for fully paid up shares in cash.
The detailed conditions for EIS investors are outside of the scope of this article, but it’s important that these are looked at.
Potential EIS pitfalls
In order to qualify for the tax free capital gains, Mark must hold the shares for a period of 3 years and must obtain the income tax relief (the £60,000).
If Mark fails to meet both conditions above, he will pay tax when he sells the shares.
In addition, it’s worth noting that sometimes the income tax relief can be withdrawn if the investor and/or the company fail to meet certain conditions. If this happens, then Mark will also lose the subsequent tax advantages.
And this brings us to the conditions that your company has to meet.
An EIS Qualifying Company
Your company must, among others requirements, be;
- An unquoted UK company
- Less than 7 years old
- Not be in financial difficulty, and
- Meet a gross asset test of not more than £15m (balance sheet total) before the share issue.
Your company can raise a maximum amount of £1m per investor and £5m per company in any one year.
And your company cannot use the funds for any other purposes including day to day working capital. The funds must be used to grow and develop your company.
Your company must also be carrying out a qualifying a “Qualifying Trade” with a view to making profits. Yes, HMRC wants some tax later on, which sounds fair.
Your activities cannot include a non-qualifying trade. Examples of excluded activities on the list of ‘non-qualifying trades’ are:
- Property development
- Nursing homes
- Financial services and Legal or accountancy services
End of EIS Schemes?
There is a sunset clause within the rules which has set a potential end date for EIS investments and tax reliefs in 2025. So companies and investors should make hay whilst the sun shines.
Similarities with the Seed Enterprise Investment Scheme (SEIS)
EIS is similar to the Seed Enterprise Investment Scheme (SEIS) with a few differences, notably the 50% income tax relief for investors under SEIS.
Also under SEIS the maximum investment that can be raised is £150,000. Plus a single investor cannot invest more than £100,000.
The Enterprise Investment Scheme is an attractive scheme and indeed HMRC wants to help you grow your company. However the rules can be complex and there are pitfalls.
Companies and investors are advised to seek professional tax and financial advice before proceeding. The last thing you want to do is upset an investor.
This guide has been written exclusively for ByteStart by Jonathan Amponsah CTA FCCA, an award-winning chartered tax adviser and accountant who helps businesses grow and scale profitably and tax efficiently. He is the CEO of The Tax Guys.