Investments in EIS-qualifying shares or investment funds provide various tax reliefs and flexibility for investors to structure their investments and reliefs to reduce their overall tax liability safely and compliantly. But what is EIS carryback?
Favourable tax treatments such as 30% income tax relief, deferred capital gains, loss relief and exemption from inheritance tax are appealing, with carryback rules permitting investors to effectively double their investment value by treating investments as having been made in the previous tax year.
While some investors might perceive these allowances and options as too good to be true, the reality is that EIS regulations are an example of good policy, providing optimal incentives to drive investment into innovation and early-stage businesses that rely on investment to scale and grow.
EIS Carry Backs Explained
The basics of the rules are that you can claim tax relief on income tax already paid in the previous tax year by carrying back income tax relief linked to an EIS investment, up to the maximum of £1 million per year, or £2 million for investments in knowledge-intensive companies or funds.
Note that these thresholds apply every tax period, so you may need to consider the optimal carry back used to avoid tipping over the maximum investment value – in which case the income tax relief claimable will be reduced.
Even smaller EIS investments, normally starting from £10,000, can be carried back to free up your full allowance for the current period and claim a rebate on income tax of up to 30% of the capital invested.
Example of an EIS Carry Back in Action
Investors with significant income tax obligations may be able to reduce their income tax owing to nil, as illustrated in the below example:
- Investor A paid income taxes of £100,000 in the 2021/22 tax period and expects to pay a similar tax bill in 2022/23.
- They intend to invest £1 million in EIS shares in the 2022/23 tax year, providing income tax relief available of £300,000.
- Because Investor A anticipates an income tax liability of £100,000, they cannot use the full tax relief since this is limited to income tax paid.
- Investor A splits their EIS investment, carrying back £500,000 to 2021/22, resulting in maximum tax relief of £150,000, offsetting the income tax paid in full.
- The £500,000 balance investment is made in 2022/23 and not carried back, providing further income tax relief against the expected £100,000 tax obligation in the current period.
Where the tax relief provided through an EIS investment exceeds the income tax paid in the current year, the carry back system allows you to maximise your use of the income tax relief provided.
Income Tax Relief on EIS Investments
The maximum income tax relief available through EIS investment is limited to £300,000 against investments of up to £1 million per tax period – although this is doubled for knowledge-intensive EIS investments.
Income tax relief of 30% means, for instance, you would be entitled to claim £300 in tax relief for every £1,000 invested, provided:
- You claim up to the maximum income tax relief within each financial year.
- You retain EIS shares or investments for three years or more.
- The company remains EIS eligible.
Your tax relief claims cannot exceed the tax paid, making it advisable for investors to utilise carry backs where their tax relief is higher than their income tax obligations in the existing tax year.
Alongside other differences between thresholds and allowances for knowledge-intensive investments, those holding assets in eligible companies or EIS funds can apply their income tax relief to obligations within the tax year when the fund closes.
The fund closure date is normally the date of the investment used for tax purposes.
Investors can also carry back the investment to the previous tax year before the fund closure date, unlike normal EIS share or fund investments, where the carry back applies based on the tax year when every individual acquisition is completed.
As with all EIS tax reliefs, investors can only claim once they have received their EIS certificate in the form of an EIS5 form for investments made in knowledge-intensive funds. The fund produces investment certification once 90% of capital has been invested and within 24 months of the fund closure.
Direct EIS share investors receive a different EIS3 certificate for each investment company based on the date the shares are allotted.
Another technical area of complexity associated with EIS shares is capital gains relief, which normally applies when an investor sells an asset or disposes of an investment for a greater amount than originally paid.
The annual capital gains allowance, which applies to all UK taxpayers, fell from £12,300 in the 2022-23 tax year to £6,000 in 2023-24, with further plans to reduce the tax-free allowance to £3,000 from April 2024 onward.
These changes mean that investors will pay capital gains tax on a higher proportion of their profits from 1st April 2023, making the EIS deferral more valuable.
Investors with large portfolios pay capital gains tax of between 10% and 28% depending on the type of asset and their earnings, which can mean a significant tax obligation arising when share assets have appreciated considerably above their original purchase value.
Among the many benefits of EIS rules, investors do not pay capital gains tax on asset growth and can use capital gains arising from other investment activities to reinvest in EIS shares to defer their obligations indefinitely until they sell the EIS shares or the company ceases to remain eligible.
There are no caps on reinvestment, and to defer capital gains, the investor only needs to reinvest the profit rather than the original investment value.
Experienced investors will always look to maximise their tax efficiency and need to ensure they have claimed income tax relief on their original EIS-qualifying investment to be able to utilise this allowance.
However, there is no requirement to have accessed a full 30% income tax relief to be eligible for capital gains tax allowances and deferrals.
Read our EIS Guides
- Are you eligible for EIS?
- What is EIS loss relief?
- What are the benefits of EIS?
- What is EIS deferral relief?
- Investing in tech EIS startups
Disclaimer: The information and opinions within this article are for general information purposes only, are not intended to provide an exhaustive summary of all relevant issues or to constitute investment, tax, legal, or other professional advice. They should not be relied on for, or treated as, a substitute for specific advice relevant to particular circumstances and you should seek your own investment, tax, legal or other advice as appropriate. In not doing so you risk making commitments to products and/or strategies that may not be suitable to your needs. Neither the writer nor EMV Capital Limited accept any responsibility for any errors, omissions or misleading statements in this article or for any loss which may arise from reliance on materials contained on this article.