The Enterprise Investment Scheme (EIS) offers investors a number of advantageous tax reliefs and allowances, encouraging investment into smaller, early-stage and unlisted businesses and funds that comply with the EIS criteria.
One of the important aspects of this tax relief package is reinvestment relief. Investors can access reinvestment relief to strategically manage their tax exposure against other gains, balance their tax liabilities between tax periods, and defer capital gains tax for the duration of the qualifying reinvestment.
EIS tax reliefs act as a ‘buffer’, reducing the risk associated with a loss or company failure and ensuring that, with careful fund or share selection and portfolio diversification, investors can use their tax allowances and reliefs to extract the full financial advantage.
How Does EIS Reinvestment Relief Work?
The basics of the tax relief are that if an investor makes a gain subject to capital gains tax (CGT), they can defer this tax burden by reinvesting the profit made into a suitable EIS company or fund.
Almost any gain exposed to CGT can be reinvested, and, provided the investor retains their EIS assets, they will not need to pay the calculated tax charge. Examples might include taxable gains realised through a property sale, a return on an investment, or the transfer of shares.
Gains can be reinvested into a suitable EIS company or fund as follows:
- Reinvested gains can be of any size, within the maximum EIS investment threshold of £1 million per year – or £2 million for knowledge-intensive companies (KICs).
- The reinvestment can occur within three years before the gain is realised and up to one year afterwards.
- Gains against which the investor has already paid CGT can also be reinvested and incorporated into current-year tax computations.
When an investor sells, transfers or disposes of their EIS investment, the original gains become taxable at the prevailing CGT charge. However, they may also reinvest the profit again into another qualifying scheme, indefinitely deferring the CGT.
Note that the reinvestment tax relief requires the investor to reinvest only the gain made. They do not need to reinvest the full value of an asset sale or transfer to benefit.
Related Reading: EIS and capital gains tax relief explained
Eligibility Rules for EIS Reinvestment Relief
As with all aspects of EIS investment and tax reliefs, investors must comply with various rules and requirements to be eligible. Requirements include:
- Being a UK resident, when the original assets were disposed of and when the EIS shares were acquired.
- Making the reinvestment within the time limits explained above.
- Reinvesting into new EIS shares and making a cash investment.
One of the flexible elements of reinvestment relief is that, depending on the circumstances, some investors may be entitled to reinvestment relief even if they were ineligible for EIS income tax relief.
Investors can also apportion the amount of their gain they decide to reinvest. In practice, this could occur where an individual has a CGT liability above the annual allowance. They do not necessarily need to reinvest the full gain into EIS shares to claim reinvestment relief.
Instead, they might opt to reinvest only the proportion of the gain above the tax-free annual allowance, reducing their CGT exposure. When the EIS shares are sold or transferred in the future, the yield will remain tax-free, provided the amount not reinvested remains below the allowance within that tax period.
When Do Deferred EIS Reinvestments Become Taxable?
Reinvestment relief is a tax deferral scheme rather than an exemption or allowance. The structure means that most investors will, at some point, pay the associated CGT. However, they can utilise tax planning as we have described to ensure gains are only realised in periods where they fall below the taxation threshold.
Claims submitted for reinvestment relief must be completed within five years after the next 31st January, which falls after the end of the tax year in which the investor reinvested into EIS shares or fund shares.
Taxpayers can submit this claim directly or as part of their normal self-assessment tax declaration process.
Deferred CGT will normally become payable if:
- The investor gifts the EIS shares to anybody other than a spouse or civil partner.
- The shares are sold or lose eligibility for the EIS.
- The investor moves outside the UK and becomes a non-resident within three years of the share issue date.
Used alongside income tax and disposal relief, reinvestment relief can make a significant difference to the total tax exposure of the individual.
Other Tax Reliefs Available Through the EIS
Income tax relief is perhaps the best-known aspect of the tax efficiencies available through EIS investment, with relief of up to 30% per annum against a maximum investment of £1 million, or £2 million for EIS funds and shares within a specific category.
Investors must retain their shares for at least three years to retain their eligibility for income tax relief. Those tax reliefs can also be carried back to reduce the tax burden linked with a previous tax year – any relief must be applied against an income tax liability.
- If EIS shares perform well and generate a return, there is normally no CGT payable when the gain on the EIS investment is realised; provided the company remains eligible and the investor has already claimed income tax relief.
- Inheritance tax relief applies when an EIS investor passes away and leaves their shares to a beneficiary. If they have held the shares for two years or more at the time of death, the heir receiving the shares is 100% exempt from inheritance tax.
- Finally, loss relief reduces the risk of an EIS company failing. EIS investors can offset the loss made after accounting for income tax relief already claimed to reduce their income tax liability and minimise the impact.
Related reading: Tax-efficient investing in the UK
It is important to recognise that the nature of a young, relatively small and unlisted company means the potential for capital losses is higher than when investing in a listed, well-established corporation with a stock exchange valuation. However, the number of beneficial tax treatments and allowances can provide excellent tax planning opportunities and effectively minimise that risk.
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.