The Enterprise Investment Scheme (EIS) provides various tax incentives and allowances to encourage investors to support unlisted, early-stage businesses with a strong potential for excellent growth.
Alongside better-known tax reliefs related to income tax and loss relief, inheritance tax exemption can be an equally important tax treatment, particularly for estate and inheritance planning and for investors focused on achieving returns or capital appreciation to pass onto their beneficiaries.
We look at what inheritance tax relief means and the criteria necessary to qualify for full exemption on inheritance tax obligations against your EIS shares or fund shares.
The Basics of EIS Inheritance Tax Relief
EIS shares or shares in EIS-specific funds are excluded from the scope of inheritance tax. They qualify for relief through the Business Property Relief (BPR) category, provided the shares have been owned for at least two years before they are assessed for inheritance tax.
With a potential tax rate of 40%, this exemption protects the value of EIS shares, the returns being generated and the growth in share value from exposure to significant rates of taxation.
Currently, UK inheritance tax is levied against a wide array of assets from liquid wealth to valuables, vehicles, properties and other belongings, investment products and portfolio assets. At the moment, the tax office will levy inheritance tax on estates valued at £325,000 or above.
Although there are different allowances related to residential property, inherited assets passed to a spouse or child, and wealth left to a charitable organisation, the ultimate outcome is that inheritance tax can be a substantial liability.
Using the EIS as a tax planning opportunity can reduce the proportion of an investment portfolio exposed to inheritance tax, preserve wealth expected to be passed to beneficiaries, and act as an efficiency exercise when combined with income tax reliefs and other allowances.
Estate Tax Planning Benefits of EIS Investment
Inheritance tax relief was introduced alongside the initial launch of the EIS in 1994, intended to incentivise investors who want to find ways to manage their investments and estate tax exposure while looking for solutions that provide exemption from inheritance tax.
Particularly beneficial for those with larger estates, EIS investment can be a viable strategy that allows for exemption from inheritance tax in minimal time.
The annual investment limit per person is £1 million, increasing to £2 million for investments in funds or companies categorised as knowledge intensive. Therefore, a sizable amount of wealth can be invested by leveraging the full threshold every 12 months.
After two years, the EIS shares or fund assets are fully exempt, provided the investor remains eligible, and the shares continue to qualify for EIS status. This timeframe is much faster than other inheritance tax planning approaches based on moving wealth into other asset classes, trusts or gifting assets.
Once shares are exempt from inheritance tax, the investor remains in control of their assets and does not need to transfer ownership of their shares to the beneficiary at any stage.
Accessing the other tax advantages, including up to 30% income tax relief, loss relief to mitigate the impact of losses made and deferrals, exemptions, and reliefs against capital gains taxation, make EIS investment highly tax efficient.
Managing Risk and EIS Inheritance Tax Exemption
The right investment strategy, of course, depends on the investor, their current portfolio and risk profile. Most opt for eligible EIS investments that are considered lower risk, reducing the likelihood that the company or fund will fail in the intervening years and result in a capital loss.
Investment risk is unavoidable, but diversifying, choosing reduced-risk funds or opting for varied EIS shares alongside other assets and classes can result in optimal tax efficiency without an unacceptable level of risk.
In many cases, the opportunity to forgo taxation obligations of up to 40% is an excellent offset against the risk of losses. Any alternative investment with a similar level of risk would ultimately be 40% less valuable over a medium to long-term investment due to the eventual exposure to inheritance tax.
However, maintaining a balanced portfolio and being mindful of the inherent risk associated with investment in early-stage and unlisted businesses is essential.
EIS Share Transfers as Part of an Estate
If an owner passes away and has EIS shares within their estate, these are treated as any other element of the estate – they can be left to any beneficiary or heir you select, whether a spouse, child, family member, trust, charity or another organisation.
The big difference is that EIS shares will be entirely free of inheritance tax obligations, provided the shares have been retained for the minimum two-year period. Investors should also note that EIS shares or fund shares obtained within three years of death are not subject to any clawbacks of any tax reliefs claimed.
Beneficiaries who receive EIS shares are transferred full ownership, although they may not be able to claim ongoing tax reliefs such as capital gains tax. Therefore, there is the possibility of a beneficiary being liable to pay capital gains tax should the shares grow in value from the date of the transfer and any disposal or transfer event in the future.
Executors of a will or trust will value EIS shares based on market value at the date of death, and this is the figure used for capital gains tax valuations should a taxable event occur.
If the executors dispose of the EIS shares and make a gain on the original valuation, the estate will also be subject to capital gains tax – although inheritance tax exemption still applies.
Choosing EIS-Eligible Shares and Funds During Inheritance Tax Planning
As we have seen, the benefits of inheritance tax exemption can be appealing and offer investors a way to reduce the future liabilities of their estate and intended beneficiaries while also accessing the other beneficial tax treatments and allowances provided by the EIS.
When assessing an investment portfolio as part of later life planning, the positives include low-taxation, high-growth assets and the potential to redirect or restructure invested wealth to effectively remove inheritance tax obligations – although caution and thorough analysis remain important to ensure the risks of an EIS investment do not outweigh the tax advantages.
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.