EIS Investment Tax Relief

What is EIS Tax Relief?

EIS tax relief is the incentive the UK government uses to attract investors to support small businesses through the Enterprise Investment Scheme (EIS). This special tax treatment allows investors to maximise their gains should the investment work out and mitigate losses if it doesn’t. 

Companies that qualify can raise up to £12 million across their lifetime but no more than £5 million per year through the EIS and similar venture capital schemes like the Seed Enterprise Investment Scheme (SEIS). 

That increases to £20 over a lifetime but no more than £10 million per year for knowledge intensive companies (KICs). A KIC is a company given a special status by the HMRC. The company, which often carries out research and innovation, is able to bring in more money through EIS and/or SEIS. 

As for angel investors, they can look forward to 30% income tax relief on annual investments of up to £1 million. Should the EIS investment turn a profit, they won’t have to pay CGT on the gains made. 

What is the Enterprise Investment Scheme (EIS)? 

The Enterprise Investment Scheme is an initiative run by the British government. It was designed to boost the UK’s economic growth by encouraging investment in risky new businesses. 

An EIS-qualifying company receives the investment it needs to hopefully grow and mature, while investors can claim tax relief. It’s a win-win for all involved unless the company fails. Even then, investors can mitigate some of their losses through the loss relief the EIS offers. 

What are the Tax Reliefs Given through the EIS?

The EIS tax investor benefits rewarded for investing in qualifying companies are:

• Income tax relief 
• Capital gains tax exemption
• Capital gains deferral relief
• Inheritance tax relief 
• Loss relief 

Below, we’ll break into each of those tax reliefs in more detail. 

Income Tax Relief – Up to 30% Shaved Off Your Income Tax Bill

Investing in EIS-eligible companies offers a significant incentive for investors, with up to 30% income tax relief available. This tax benefit helps mitigate some of the risks typically associated with funding small businesses. Investors can claim relief on investments up to £1 million per tax year, potentially saving as much as £300,000 in income tax.

The tax relief is applied to the year in which the funds are actually invested into a company. However, when investing through an EIS fund, this timeline may differ, as the fund’s allocation process can extend over a period of time.

For those investing in unapproved EIS funds, there’s flexibility to backdate an investment to the previous tax year, which can be a strategic tool for tax planning. This provision also allows a maximum investment of up to £2 million to qualify for tax relief within a single tax year – £1 million allocated to the current year and £1 million carried back.

To maintain eligibility for the relief, investors must hold their shares for at least three years, and the company must retain its EIS-qualifying status for the same period. If these conditions are not met, the tax relief may need to be repaid to HMRC. It’s also important to note that the relief can only offset an income tax bill for a given year, and it cannot result in a tax refund or reduce the bill below zero.

Capital Gains Tax Relief – Tax-Free Growth

If you do your homework to identify an EIS-qualifying company that has huge growth potential, the capital gains tax relief you receive is one of the biggest benefits of the Enterprise Investment Scheme. 

When you sell the EIS shares, you’re free of paying capital gains tax. Any gains you make from the investment are 100% tax-free. 

That is huge news, considering CGT is currently 18% or 24%, depending on your tax bracket. Let’s say you invest £1 million into a company, and it flourishes. You then decide to sell the EIS shares for double that amount. You’d usually have to pay CGT of £180,000 or £240,000 on your £1 million gain.

Not through an EIS-qualifying investment, you won’t. As long as you held the EIS shares for at least three years from the time of purchase, that gain is free of CGT. 

It’s also important to note that the company must remain eligible for EIS funding throughout those three years for you to qualify for CGT tax relief. 

Capital Gains Deferral Relief – No CGT

Capital gains from the sale of other assets can be reinvested into EIS shares and deferred for the duration of the investment. Notably, there is no cap on the value of gains that can be deferred under this scheme.

It’s essential to remember that it’s the gain itself, and not the total sale proceeds, that needs to be reinvested. For example, if an asset is sold for £60,000 but originally cost £20,000, the resulting gain is £40,000. This £40,000 must be reinvested into EIS-qualifying shares to qualify for capital gains tax (CGT) deferral relief.

To be eligible for this relief, the reinvestment must occur within a specific timeframe: no earlier than 12 months before or up to three years after the original gain was realised.

The deferred gain remains in suspension until one of the following events occurs:

• The EIS shares are sold.
• The company loses its EIS-qualifying status within three years of the investment.
• The investor stops being a UK resident within three years of the investment.

When the gain is brought back into charge, it will be subject to capital gains tax at the prevailing rate. However, if the gain is reinvested into new EIS-qualifying shares, it can be deferred again. 

Inheritance Tax Relief – Passing on Wealth Without Taxes

Although a tax relief you will not benefit from directly, the 40% saved by beneficiaries of your money invested in EIS companies is another big incentive. 

If you’re planning to pass on your wealth and want to give as little of it to the government as possible, using the Enterprise Investment Scheme could prove a worthwhile strategy. 

As long as you’ve held the investments for at least two years at the time of your death, they’re not subject to any inheritance tax. 

Loss Relief – Helps Mitigate Any Losses

It’s important to remember the reason investors can claim EIS relief at all. That’s because investing in early-stage companies is a risky business. More than half of all start-ups will fail within the first three years.

That’s why shrewd investors previously avoided this type of investment. The incentive to claim tax relief is why some have been encouraged to take on an investment they would otherwise avoid. 

Loss relief is another of those tax benefits. Although, it’s only a benefit if the investment turns sour. It reduces the impact of the losses made. Depending on your tax bracket, you can claim back 20% or 45% of those back on your capital gains or income tax bill. 

What are the Qualifying Criteria for an EIS Investor?

If you’re interested in the investment tax relief offered by the Enterprise Investment Scheme, you must meet certain criteria:

• Must be a UK taxpayer.
• Cannot be employed by the EIS company or hold more than 30% ownership.
• The company must issue full-risk ordinary shares that you purchase upfront in cash.
• The maximum amount you can invest into the scheme per year is £1 million. However, that can increase to £2 million if £1 million of that is invested in a knowledge-intensive company. 
• You must hold the shares for at least three years to claim income tax relief and some of the other tax breaks. 

If you meet the above criteria, nothing is stopping you from seeking out EIS investment opportunities. 

What are the Qualifying Criteria for a UK Company?

As for any company looking for investment to help them grow and mature, the following are the main criteria:

• Must have a permanent UK establishment.
• Only companies that made their first commercial sale less than 7 years (10 for a KIC) ago can qualify for investment. 
• Have no more than 250 full-time employees (500 if a KIC).
• Cannot have total gross assets of over £15 million. 
• Must carry out a qualifying trade.

The last criterion on that list is regarding the business sector and activity of a company. Generally, businesses in the property, legal, and financial sectors cannot qualify for EIS. The farming and energy sectors are two others. 

Advance Assurance

While a company is waiting for the result of its application to the EIS scheme, it can apply for Advance Assurance. 

This is an assurance from the HMRC that the company ticks the most important criteria and is likely to qualify for EIS tax relief. 

The company can show this to potential investors and begin negotiations before they officially qualify as an EIS company.

How to Claim EIS Relief

EIS tax relief must be claimed after the funding round is complete and within five years from the 31 January following the tax year in which the investment was made. This aligns with the deadline for submitting self-assessment tax returns in the UK.

It’s important to note that unused income tax relief cannot be carried forward to future tax years. If an investor doesn’t fully utilise the £1 million investment limit, the remaining allowance cannot be transferred to the next year. 

However, there is flexibility to backdate EIS relief to the previous tax year, offering a useful option for maximising tax benefits.

Before an investor can claim income tax and any other tax breaks, the EIS company must first complete the following:

Step 1: Submit a compliance statement to HMRC

Four months after receiving the investment, the company must complete the EIS1 compliance statement and submit it to HMRC. 

The HMRC will review the compliance statement before determining if the company is eligible for EIS funding. The process can take anywhere from a couple of weeks to a few months. 

Step 2: Receive approval from the HMRC

If the company meets the criteria of EIS and is accepted into the scheme, it will receive an EIS2 letter from HRMC. 

That letter is the company’s authorisation that it is now an EIS company. It will also contain a Unique Investment Reference number (UIR) for the share issue.

Step 3: Give investors compliance statements

The most important step for an investor is receiving a compliance statement from the company they’ve invested in. 

The EIS3 document is evidence of their investment and what they will need to claim their EIS tax relief. The compliance statement must be sent along with the investors’ self-assessment tax return. 

Please remember: While the tax breaks offered by the Enterprise Investment Scheme are significant, you shouldnt invest purely for those incentives. This type of investment is risky. 

We strongly recommend you think long and hard about any potential EIS investment. Remember that half of new startups fail within the first few years. No matter the potential of a company, the risk is there.