Deferral relief is one of the many tax advantages available for investors engaged in funds or shares that qualify for Enterprise Investment Scheme (EIS) tax reliefs.
Having launched back in 1994, the EIS is a well-established, government-backed venture capital scheme designed to stimulate investment into the UK business sector, aimed at earlier-stage companies and unlisted firms.
While income tax relief is often the best-known aspect of EIS tax treatments, deferral relief can be just as attractive and benefit investors with Capital Gains Tax (CGT) liabilities.
How Does EIS Deferral Relief Work?
The concept is simple; when you dispose or transfer an asset that gives rise to a CGT obligation, rather than paying the tax levy, you can reinvest the gain (rather than the full investment value) into EIS shares or an EIS fund and delay the payment indefinitely.
From April 2023, the CGT allowance, above which the tax charge becomes payable, has reduced considerably from £12,300 to £6,000. In the next tax year, the tax-free allowance will drop again to £3,000, creating a much higher tax bill for those selling assets liable for CGT.
CGT tax rates vary from 10% for taxpayers in the basic income tax band up to 20% for higher-rate taxpayers, so, for example, selling an asset – excluding a residential property – with a £100,000 profit and less the annual allowance will mean a CGT tax charge of £18,800.
EIS deferral relief allows taxpayers to reinvest their profits into a qualifying fund or company, deferring that tax bill. However, the incentive is more appealing when we consider that investors can leverage EIS deferral relief even if they have yet to realise the gain.
Timescales for EIS Deferral Relief Claims
HMRC’s guidance states that any investor who purchases EIS shares or an EIS-eligible fund investment within the following periods can apply for deferral relief:
- Within 12 months before, OR
- Up to 36 months after the disposal date.
The conditions also indicate that HMRC has certain discretion to extend those time caps, which means that, in some circumstances, EIS share acquisitions may qualify as a deferral relief exercise over a broader period.
Taxpayers have a generous amount of flexibility because, provided their reinvestment is within an acceptable period, they can claim deferral relief up to five years after the next 31st of January following the tax year the shares were issued.
Effectively, a taxpayer could lodge a deferral relief claim over an eight-year span without incurring a CGT tax charge.
Note that, regardless of when you claim deferral relief, you must have the EIS3 certificate to prove your reinvestment.
Does EIS Deferral Relief Remove a Capital Gains Liability?
Although deferral relief can be highly beneficial, the principle is that investors can defer their CGT liability until a later date rather than remove the obligation altogether.
However, deferring a CGT charge can be worthwhile, for example, delaying the bill until another tax year in which you have yet to use all of your personal allowance.
Another strategy is to use tactical EIS investment, although a degree of risk and uncertainty is unavoidable. For example, in our above illustration, the £18,800 tax bill might be deferred until a later tax year. Alternatively, the investor could look for high-growth EIS shares or fund assets with the expectation their reinvested £100,000 will grow in the meantime.
EIS gains are not usually subject to CGT, conditions notwithstanding. If the £100,000 became worth £150,000 over the minimum three-year retention period, the £50,000 non-taxable gain would cover the £18,800 liability, with a residual £31,200 return.
Reinvesting the EIS-generated gain into a different investment, with EIS status, would further defer the original gain, meaning that there is scope to repeat the exercise indefinitely without the £18,800 obligation being removed but without it becoming payable.
Limitations on EIS Deferral Relief
There are few restrictions on deferral relief and provided your investments, declarations, and reinvestments are compliant and correctly recorded you can theoretically defer a CGT tax bill for as long as you wish.
HMRC does not impose any cap on the total value of gains you can defer – the core requirement is to keep reinvesting profits made into qualifying EIS companies or funds.
Alongside deferral relief, investors can also access the following:
- Disposal relief, where EIS shares held for three years and where the investor has claimed the applicable income tax relief, are exempt from CGT on EIS share disposals.
- Loss relief – providing an offset to reduce the financial loss where an EIS investment fails or drops below the original invested value.
These combined tax reliefs can be valuable and, when applied strategically, can make a significant difference to an investor’s overall tax position and liabilities.