Discover the benefits of Enterprise Investment Scheme tax relief and decide if the EIS is right for you.
The UK is a hotbed for new business start-ups, but many will fail without receiving the investment they need to stand a chance to enjoy growth. For investors, it is risky to put money into early-stage companies with a high chance of failure.
That said, with high risk can come high reward due to the potential massive gains should a young company realise its potential. Despite that, more savvy investors usually stay away from such high-risk investments, which is why the UK government has set up initiatives that offer tax benefits that do take the chance.
The Enterprise Investment Scheme (EIS) is one of those initiatives. Launched in 1994, it encourages investment into small early-stage UK businesses through offering tax breaks, including income tax relief, tax-free growth, and capital gains deferral.
Is EIS tax relief worth the risk, or are you, as an investor, better off waiting for less volatile investment opportunities? By the time you’ve read our guide, hopefully, you’ll have your answer.
The EIS Tax Reliefs Offered to Investors
As you’ll see below, there are some significant tax breaks and other benefits offered to investors who invest through the EIS scheme. They can benefit from deferred gains, not have to pay capital gains tax on their investment, and can receive up to 30% income tax relief, among others.
30% Income Tax Relief
One of the biggest selling points of initiatives such as this one is the income tax relief an investor can claim when filing their tax return.
Let’s look at how qualifying investors can benefit their tax bill through an investment via the EIS:
- An angel investor who holds no more than a 30% interest in an EIS-qualifying company can reduce their tax liability by up to 30% of the amount invested. EIS shares must have been held for at least three years since their issue or until three years since the company began trading, if later.
- There is no minimum investment required per EIS company. The maximum allowed to claim tax relief is £1 million, meaning tax savings of up to £300,000 per year.
- Individuals can carry back their EIS subscription, up to the annual allowance, to the previous tax year for income tax relief. This allows up to £2 million to be invested, with £1 million applied to the prior year.
- Furthermore, as each individual has a yearly EIS allowance capped at £1 million, a married couple could, therefore, invest up to £2 million per year.
- Income tax relief is only available up until an investor’s income tax liability is used up.
Capital Gains Tax (CGT) Freedom
Another significant benefit of the Enterprise Investment Scheme is the capital gains tax relief that investors can claim.
If EIS shares have been held for at least three years and make a gain at the time of sale, capital gains tax is not payable on that gain. CGT relief is only applicable to the net cash investment after any income tax relief has been claimed.
Below is an example of how a successful investment in a company with EIS-qualifying status could look after income tax relief and capital gains tax relief that has been applied.
| Initial Investment | £200,000 |
| Less 30% Income Tax Relief | (£60,000) |
| Net Outlay on the EIS Investment | £140,000 |
| The Investment’s Realised Value After 3 Years | £300,000 |
| Total Return (CGT-Free Profit + Income Tax Relief) | £160,000 |
Capital Gains Deferral Relief
If you have other assets and want to defer capital gains tax, you can make an EIS-qualifying investment using those gains. You can take advantage of this CGT deferral relief for as long as you like and even indefinitely if you so choose.
You should note that it is the gain and not the proceeds of the sale that are required for the investment to qualify for Capital Gains Tax deferral. For example, if you sold an asset for £100,000 that originally cost £50,000, it would result in a net gain of £50,000. To defer the gain, it is that £50,000 you would need to invest
CGT deferrals apply as long as the EIS-qualifying shares were bought from the gains of other assets that were realised up to 3 years prior to the investment or up to 1 year after.
Unlike income tax relief, the deferral relief you can claim is not limited. You can claim tax relief on investments over £1 million, while even investors with a company interest exceeding 30% can receive the CGT deferral.
Loss Relief
There are no guarantees when investing, especially when it’s in an early-stage EIS-qualifying company. Not having to pay CGT and receiving 30% income tax relief on your investment is only great if the EIS-qualifying business enjoys continued growth.
That said, there is an EIS tax relief that helps offset any losses suffered when selling your EIS shares. If that happens, the loss, after deducting income tax relief, can be offset against your current or previous year’s income tax bill.
Loss relief applies only if your investment falls below its effective cost, which is your total investment minus any claimed income tax relief. For example, if your investment was £150,000 and you claimed 30% (£45,000) off your income tax bill, the effective cost of your EIS investment is £105,000.
How much loss relief you receive is calculated by multiplying the effective cost by your current tax rate. As an example, if you’re on the higher 45% additional rate taxpayer band, you can claim back £54,000 of your losses back on your income tax bill.
Inheritance Tax Relief
Inheritance Tax (IHT) is often a sensitive topic for families and investors. However, avoiding later-life planning as an experienced investor can lead to significant consequences.
The current UK inheritance tax rate is a whopping 40%, meaning close to half your estate could go to the government once you pass.
However, one of the incentives the UK government uses to encourage investment in smaller companies is inheritance tax relief. What that means is that once sold after your passing, your EIS shares are free of inheritance tax and will carry their full worth when passed to your beneficiaries.
What Companies Qualify for the Enterprise Investment Scheme?
Any young company that meets the requirements we’ve laid out below, can apply for EIS relief through this government initiative.
- Eligibility Criteria: Firstly, companies must be UK-based and have been trading for less than seven years since their first commercial sale. On top of this, they must employ fewer than 250 people and hold gross assets of no more than £15 million before issuing shares.
- Usage of Funds: Funds must be deployed in qualifying business activities within two years of the investment or the commencement of trade, whichever comes later.
- Advance Assurance: Businesses should seek advance assurance from HMRC by submitting a business plan and financial forecasts to confirm eligibility. Advance assurance is something potential investors will want to see before they enter into investment negotiations. It is an early assurance from the HMRC that the company is likely to qualify for the EIS scheme.
A Brief History of EIS
The Enterprise Investment Scheme was initially launched at a time when the UK was still recovering from a recession that slowed down economic growth and brought high unemployment rates. At the time, the tax incentives included 20% (now at 30%) income tax relief and the CGT relief and gains deferrals that are still offered today.
Over time, the EIS evolved with higher investment limits and broader eligibility criteria, making it more accessible to UK businesses and investors alike. By 2021-2022, the scheme had supported around 31,500 companies, raising over £24 billion, particularly benefiting sectors like technology and healthcare.
The scheme has received criticism for its complexity, but even the harshest critics cannot deny the increase in job creation and economic growth that has come as a result of the EIS.
Understanding the Risks of Investing Through the Enterprise Investment Scheme
While most investors hope and pray that their EIS investment results in huge gains, we should point out the substantial risk this type of investment carries.
The United Kingdom boasts a vibrant startup ecosystem, especially due to initiatives like the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) encouraging investment through tax benefits.
However, it is tough for early-stage companies in such a thriving economy. Competition is fierce, so without adequate funding, many go under.
Here are some quick facts about new businesses in the UK:
- 60% of new UK businesses will fail within three years of inauguration.
- 4% fail within the first year.
- 34% fail within two years.
- Over 60,000 new businesses have launched in the UK between 2018 and 2023, but today, only around 20,000 are still going.
Those statistics are quite startling, but they showcase the reasons why you should not rush into an EIS investment until you’re confident it will pay off.
What to Consider When Choosing an EIS Investment
Taking those risks into consideration, you’ll want to ensure that you pick the right EIS-qualifying investment. No matter what you do, the risks are great. However, by doing plenty of due diligence and considering the following tips, you stand a greater chance of making a successful investment.
Consult a financial adviser
Before making any investment, whether in EIS or venture capital schemes, seek advice from a financial advisor who has a strong understanding of your circumstances, risk tolerance, and long-term goals. A qualified professional can help you tailor your investment to best suit your needs.
Assess the Risks Involved
Investing in EIS-qualifying companies carries high risks. These unlisted companies may lose value entirely and are difficult to sell. Loss of EIS status requires repayment of tax reliefs, and future reliefs are subject to tax rule changes.
Ensure you consider those risks and understand them before going ahead with an investment. While it’s nice that you can claim income tax relief and other tax benefits, you’ll come out down if the EIS company fails.
The Takeaway
The Enterprise Investment Scheme presents a unique opportunity for investors prepared to navigate the risks of investing in early-stage businesses. Its benefits, including income tax relief, capital gains deferral, inheritance tax exemptions, and loss relief, make EIS one of the UK’s most appealing tax-efficient investment options.
However, we urge you not to let those tax advantages cloud your judgment. Those tax breaks are offered for a reason, and that’s because of the high-risk nature of such an investment.
If you’re considering the EIS as an investment avenue, speak to a financial advisor before anything else. A professional can help you weigh whether this type of investment is the right one for you in the current circumstances or whether there are better options out there.
