Understanding the Enterprise Investment Scheme (EIS)

A Brief Summary of the Enterprise Investment Scheme (EIS)

The Enterprise Investment Scheme (EIS) is an investment programme created by the UK government to aid economic growth across the United Kingdom. It does this by giving investors tax benefits in return for investing in new start-ups or smaller businesses that are not guaranteed to succeed.

These investments are considered risky, which is why an investor is given tax relief in return for their EIS investment. Money raised for an EIS-qualifying company can help it grow and succeed, which, in turn, gives a boost to the UK economy.

EIS Key Points

• The Enterprise Investment Scheme is a UK initiative that offers smaller companies an easier way to raise money.
• The EIS persuades investors by allowing them to claim tax relief benefits – making the purchase of qualifying companies shares more attractive.
• Investors receive income tax relief, exemption from capital gains tax, loss relief, and inheritance tax reliefs.

Understanding the EIS Investment Scheme

Smaller companies and new businesses previously, and still do to some extent, face difficulties raising capital. Without investment, these companies are more likely to fail. The EIS is a government-sponsored programme designed to improve the chances of these smaller companies by making investment in them more appealing to investors.

While there is no guarantee that these riskier investments will pay off, if they do, investors can reap the benefits of that investment as well as the tax relief benefits offered by the scheme. The economy receives a boost through business, production, and job growth.

This is how the EIS scheme works:

• Investors purchase shares in a chosen EIS-qualifying company they believe has a chance of succeeding. Shares are paid in full and in cash.
• These shares do not grant any special rights to the company’s assets and cannot be redeemed. However, businesses are permitted to provide shareholders with limited preferential rights to dividends, provided that these dividends do not accumulate over time.

Companies wishing to benefit from the EIS scheme must meet certain qualifying conditions. The business entity is also only allowed to use the investment for EIS-approved purposes.

Any company that qualifies for the scheme and is happy to receive investment from an individual investor must issue a compliance statement. This allows the investor to claim tax relief on that investment.

That relief is up to 30% on any EIS investment up to £1 million. The 30% can also apply to investments up to £2 million, as long as at least 50% of that investment is in a Knowledge Intensive Company. Knowledge Intensive Companies are those that carry out research and development on new innovations.

Did you know?

When an individual decides to sell the EIS shares in a company on the programme, they’re exempted from paying capital gains tax.

The History Behind the Enterprise Investment Scheme (EIS)

The Enterprise Investment Scheme is an initiative that first rolled out in 1994. It was created with the core purpose of boosting the UK economy through encouraging and rewarding private investors to invest in smaller companies considered high risk.

There have been many changes to the initiative over the years, especially with regard to the tax benefits for investors. For example, capital gains tax relief was first introduced to the program in 1999.

Many other changes have been made to the EIS over the years too, contributing to its continued success and attractiveness to investors. Since EIS was established, it has provided over £12bn to nearly 23,000 smaller companies and start-ups.

Other Venture Capital Schemes in the UK

The EIS is not the only venture capital scheme operated by the government of the United Kingdom. Another scheme is the Seed Enterprise Investment Scheme, while a third, the Social Investment Tax Relief Scheme, stopped accepting new investments in April 2023. Investors also have the option of Venture Capital Trusts, which also help qualifying companies raise money.

Here’s a bit more on each of those alternative schemes:

The Seed Enterprise Investment Scheme (SEIS)

The SEIS and the EIS are similar in that they offer tax reliefs to investors. However, the difference between the two comes down to the types of companies on the program and how much tax relief is provided.

The state-aid-approved SEIS focuses more on start-ups, while the EIS is aimed at more established smaller businesses. As there is more risk when investing in start-ups, the SEIS provides investors with 50% income tax relief, although only on investments up to £200,000. Similar to the EIS, investors can also benefit from other reliefs, including inheritance tax relief, CGT relief, and loss relief on SEIS investments.

The Venture Capital Schemes

Another option for both investors and smaller companies is to consider a Venture Capital Trust. These work slightly differently from the EIS but also offer up to 30% upfront income tax relief. Rather than investing in a company directly, you purchase shares of one of the dozen or so venture capital companies.

These are London Stock Exchange-listed companies that specialise in making new investments in startups. By purchasing VCT shares, you are investing in the performance of all the companies the VCT has invested in. Investors receive growth as a dividend, and this type of investment is seen as safer and more stable since it covers the full portfolio of the VCT’s companies. Those dividends come tax-free, which is another significant benefit of this type of investment, in addition to the 30% income tax relief on the initial investment.

Qualifying for the Enterprise Investment Scheme – Investors and Companies

There are specific requirements that an investor and a company must meet before they can be considered for and qualify for participation in the Enterprise Investment Scheme.

How a Company Can Qualify for the EIS

Any small to medium-sized company hoping to qualify for capital from individual investors must meet several requirements. The following are some of the most important:

• The company must be based in the UK.
• It must have made its first commercial sale within the last seven years.
• The company must not be listed on the London Stock Exchange or any other stock exchange.
• It must not have more than 250 full-time employees or gross assets of more than £15 million.
• There is a lifetime cap of £12 million on the money a company can receive from the EIS or any other government programme.
• The most capital gain from investments that a company is allowed within a year is £5 million.

Furthermore, any investment money raised by the sale of shares as part of the EIS must be used for approved purposes. These include spending it on the research and development (R&D) of a qualifying trade or putting it towards a qualifying trade that is ready to operate now or will be operational within two years.

Finally, so that investors can receive EIS tax relief, the company must submit a compliance statement.

Qualifying as Knowledge Intensive Companies

Companies classed as Knowledge Intensive have slightly different criteria to meet but can also receive more capital from the EIS scheme. That also translates to bigger tax benefits for investors in these companies.

What is a Knowledge Intensive Company(KIC)?

Knowledge Intensive Companies are organisations that operate in areas such as development, research, or innovation. That company must be performing qualifying activities at the time of issuing shares and must adhere to the following criteria:

• It spends at least 15% of its operating costs on development, research, or innovation or has spent at least 10% in the three previous years.
• Is engaged in activities with the intention of developing intellectual property on the date of share issuance.
• Can show that this intellectual property and the company’s work on this property will be the primary focus of the company for at least the next decade.
• The company has no more than 500 full-time employees.

Any company that qualifies for KIC classification can receive double (up to £10 million) per tax year in funding from the EIS scheme. Furthermore, the total lifetime investment cap is now £20 million instead of the £12 million of other EIS firms.

Investors in KIC companies can now invest up to £2 million, which is double what’s possible with a regular EIS company. Once shares have been held for at least three years, investors can receive a maximum of £600,000 tax relief per year.

How an Investor Can Qualify for the EIS

While most criteria pertain to the investor’s previous or current relationship with the qualifying company, anyone looking to invest via the scheme must also meet certain criteria:

• Must not be an employee, have a vested interest in, or have made a previous investment in the company.
• Company shares must be bought using cash and made directly to the business entity.
• The investor must hold the shares for at least three years.
• An investor can claim EIS tax relief up to five years after investing.

A Quick Look at the Investor Benefits of the Enterprise Investment Scheme

Income Tax Relief

When you invest in an EIS-qualifying company, that money qualifies for up to 30% income tax relief. You can invest up to a maximum of £1 million throughout a tax year, so doing the math shows you could enjoy tax relief of £3 million per tax year once you have held the shares for at least three years and have sufficient Income Tax liability to cover that relief.

Capital Gains Tax Relief (CGT)

If your EIS journey is successful and you sell the shares at a profit, any capital gains are tax-free. This could provide a significant tax break if the company has enjoyed substantial growth thanks to your decision to invest.

The EIS tax reliefs do not end there, you’ll also receive:

• Capital Gains Tax Deferral Relief: Another benefit investors can take advantage of is capital gains tax deferral. If you invest using capital gains from other investments or the sale of other assets, the capital gains tax you’d usually have to pay is deferred.
• Inheritance Tax Reliefs: Your family will also benefit from inheritance tax relief on the money you invested as long as you have held the shares for at least two years prior to your death.

Enterprise Investment Scheme (EIS) FAQs

What are the main benefits for an investor in the EIS scheme?

Investors can claim up to 30% income tax relief of up to £300,000 every tax year once they have held shares for at least three years. They’re also given capital gains tax relief if the shares are sold at a profit. Investors also receive inheritance tax relief and loss relief benefits should the EIS company fold.

What are the main requirements for a company to qualify for the EIS?

The company must have made its first commercial sale within seven years, not have more than 250 employees, or have gross assets of more than £15 million. It must also operate within the UK and not be listed on the London Stock Exchange.

How long must I hold shares under the scheme to receive tax breaks?

Three years is the minimum length of time required to hold EIS company shares before you can claim income tax relief.

Who can invest in an EIS company?

Anyone who has no affiliation with the specific EIS company requiring additional capital can invest. As long as you’re not an employee or have previously invested, you should qualify.

What are the alternatives to EIS?

Venture Capital Trusts (VCT) and The Seed Enterprise Investment Scheme (SEIS) are two alternatives you might consider. Both allow you to invest in start-ups or smaller-sized businesses and give you tax relief in return.