The Enterprises Investment Scheme (EIS) was first introduced in 1994, and replaced its predecessor, the Business Expansion Scheme.
The rationale behind the Enterprise Investment Scheme (EIS) is to provide tax benefits to encourage investment in small, unquoted trading companies.
An awareness of the scheme is required by both potential qualifying companies seeking third party investment, and investors alike. This document serves as an introduction to the scheme.
Income tax relief calculated by reference to the lower of:
- 30% of the qualifying investment up to a maximum of £1 million of aggregate qualifying investment made in a tax year; and
- The investor’s tax liability for the relevant tax year.
The income tax relief can be claimed in relation to the tax year in which the qualifying shares are issued, or alternatively can be carried back to the previous tax year.
The relief is withdrawn where the shares are sold, the company ceases to qualify, or the investor ceases to qualify within the 3 year period following the issue of the shares.
Any dividends received are subject to income tax (subject to the new £5,000 annual dividend allowance effective from 6 April 2016) – in theory dividends are not usually paid by qualifying companies.
It is possible to claim a capital loss arising on the disposal of EIS shares as a deduction against the investor’s taxable income (and thus receive income tax relief). The combination of both this favourable treatment on the realisation of a capital loss and the EIS income tax relief available on acquisition significantly mitigate any commercial loss suffered on a qualifying investment.
Capital gains tax
Any capital gain realised on the disposal of EIS shares is exempt for capital gains tax purposes. It is, however, vitally important that EIS income tax relief is claimed on the original acquisition of the shares to qualify for this capital gains exemption.
Additionally, EIS capital gains deferral relief is available. Capital gains realised in the period beginning 3 years prior to the issue of qualifying shares and one year after can be deferred into the EIS shares acquired up to the value of the qualifying investment. Thus, no capital gains tax is payable on the deferred gain until the EIS shares are disposed of. The capital gains tax payable on the deferred gain is then subject to capital gains tax at the rate at the time of the disposal of the EIS shares. This deferral relief represents a cash-flow advantage, however, there is a risk of suffering an increased capital gains tax liability on the deferred gain if the capital gains tax rate increases in the deferral period (the flip side being that there is also the opportunity for tax savings where the rate decreases).
100% Business Property Relief should be available on the value of EIS shares after the shares have been held for 2 years, providing the company remains an unquoted trading company.
Both the company seeking EIS status and the investor must meet multiple conditions in respect of each share issue/acquisition in respect of which EIS is considered.
The conditions relating to a company include:
- The company must be unquoted;
- The company must carry on a ‘qualifying trade’ – some trades are categorised as ‘excluded trades’ for these purposes, and thus are not ‘qualifying’;
- The company must have a ‘permanent establishment’ in the UK;
- The company must not be controlled by another company or own shares in another company which it does not control (i.e. has less than 51% ownership) – significant care needs to be taken where an EIS approved company embarks on a reorganisation of any sort;
- The company must have less than 250 employees at time of the relevant share issue; and
- The company must have gross assets of less than £15m prior to the share issue, and less than £16m post the share issue.
Given the numerous and sometimes complex conditions, and how valuable the tax benefits are to investors, it is vital to obtain advice from a firm of experienced tax professionals when considering applying for EIS approved status from HM Revenue & Customs, and administering the scheme. The rules are generally considered to be a minefield, and thus it is prudent to obtain advice from an experienced firm such as ourselves.
The conditions relating to the investor include:
- The shares must be acquired by way of subscription (i.e. purchase from another investor will not qualify) and fully paid up; and
- The investor must not be connected with the trade carried on by the Company (not this can catch scenarios where the trade was previously carried on by another entity) within the period beginning 2 years prior to the share issues and three years after. For these purposes ‘connected’ includes being an employee (including directors and other office holders), and owning more than 30% of the company together with associated persons. There is a particular exemption for investors who become directors post making an investment and are only paid a ‘reasonable remuneration’.
Please note that the investor can be ‘connected’ if they are only seeking capital gains deferral relief in respect of an investment in a qualifying company.
Updated 21 February 2019
This publication has been prepared by RRL LLP. It is to be treated as a general guide only and is not intended to be a comprehensive statement of the law or represent specific tax advice. No liability is accepted for the opinions it contains, or for any errors or omissions. All rights reserved.