EIS Examples – How does EIS work?

The Enterprise Investment Scheme (EIS) provides investors with tax reliefs and beneficial treatment to reduce the risk linked with investing in smaller, unlisted and earlier-stage businesses. But how does EIS work? What are some examples of EIS investments?

This guide explains how those tax reliefs work in practice, what happens if an EIS investment makes a loss, and how loss reliefs and capital gains tax deferrals provide additional tax advantages.

 

EIS Example 1: EIS Shares Grow in Value

Our first example looks at a best-case EIS investment example where the business grows and provides a return via capital appreciation as the share value increases. In our first case study, our investor buys fund shares worth £10,000 and is an additional rate taxpayer with an income falling into the highest 45% tax band.

The initial income tax relief is 30% of £10,000, so £3,000 is deducted from the investor’s income tax liability. If the company shares double in value, after the three-year minimum retention period, they will have grown from £10,000 to £20,000.

Because EIS shares are exempt from capital gains tax, the investor can sell the shares for £20,000, making a total profit of £13,000 based on gains and income tax relief combined.

If we consider a larger investment of £100,000, these calculations work very much the same, assuming the company shares grow by 150% in value over the three years.

  • The original investment of £100,000 qualifies for income tax relief of £30,000 – making the net investment value £70,000.
  • After three years, the shares have grown to a valuation of £250,000, producing a total gain of £180,000 less the net investment, or a return of 257%.

EIS Example: Investment Value Remains Static

If an EIS investment remains worth the same value over the three-year minimum investment, the net gain equals the income tax relief claimed – unless the investor has used the investment as a reinvestment opportunity to offset other capital gains tax liabilities.

An investment of £10,000 qualifies for £3,000 income tax relief or a net gain of £3,000 if the shares do not change in value. However, most EIS investors treat these shares as a medium to long-term investment, so any further gains in the years to come will add to their net returns.

EIS Example: Fund Assets or Shares Fall in Value

Loss relief provides a financial ‘cushion’ to reduce the impact of making a loss on an EIS investment. If we take the above basic example, this will mean that should the shares become worthless:

  • The original £10,000 investment still qualifies for £3,000 income tax relief, putting the total capital at risk of £7,000.
  • If the company fails and the shares have no value, the investor can claim loss relief based on their tax bracket and the exposed capital. In this scenario, that would be calculated as £7,000 x 45%, or £3,150.

Therefore, the actual loss would be £3,850 of the original £10,000, including income tax relief and loss relief.

As with our earlier illustrations, EIS loss relief works the same way regardless of the size of the investment, provided the investor and the company remain eligible and compliant with the conditions and requirements.

If we invested £100,000 into an EIS fund and the realised value of the shares at the end of the three years was zero, the figures would look like this:

  • £100,000 initial investment, less £30,000 income tax relief leaves £70,000 capital at risk.
  • The investor would qualify for £31,500 in loss relief, based on 45% x £70,000.
  • After income tax and loss reliefs, their net loss would be 38.5%, or £38,500.

These examples demonstrate the value of loss relief and how this, combined with EIS income tax relief, provides mitigation against the potential of making a loss where an early-stage company does not grow as expected.

EIS Tax Reliefs Explained

Although the primary tax relief is income tax-related, there are various other tax treatments specific to EIS shares and funds, which can make a marked difference in exposure to capital gains tax and the impact of losses.

EIS Income Tax Relief

Income tax relief is available up to 30% against a maximum £1 million annual investment. Investors buying into knowledge-intensive EIS companies (KICs) receive the same tax relief percentage but against a higher maximum investment threshold of £2 million.

The maximum tax relief is £300,000 a year (or £600,000 for KIC investments) and can be offset against income tax liabilities in the current or previous tax years.

However, shares must be kept for at least three years to remain eligible for income tax relief. Investors who have claimed income tax relief but disposed of their shares before this period may find their tax reliefs are withdrawn and repayable.

Capital Gains Tax Relief on Disposal

Provided the investor has met the three-year retention period and claimed income tax relief, they are not exposed to capital gains tax when the shares are sold. EIS shares are exempt from tax against capital growth.

EIS Loss Relief

Loss relief applies where EIS shares or fund assets fall in value and are sold beneath the original investment price or the company fails. The investor can opt to offset the loss suffered against their income tax liability either in the current or previous tax year. 

Reinvestment Relief 

If an investor makes a gain on other assets within their portfolio that are not linked to the EIS, they can defer their capital gains tax obligation indefinitely by reinvesting the profit (rather than the amount originally invested) back into eligible EIS shares.

Reinvestments must be made within 12 months before and 36 months after the gain to qualify for reinvestment relief.

Capital gains tax deferral applies until the investor sells the EIS shares, their investment no longer qualifies for EIS treatment, or if they move outside the UK within three years of the original reinvestment date.

A final tax treatment to be aware of is inheritance tax relief, where EIS shares or fund shares are included within the scope of Business Property Relief. Investors can leave shares to their beneficiaries or heirs tax-free, provided they have held them for at least two years. Read more about tax-efficient investing in the UK here. 

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.

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