The Enterprise Investment Scheme (EIS) is a government-backed initiative that provides tax incentives for investors contributing to early-stage and smaller companies with strong growth potential, many of which fall outside the scope of other investment opportunities.
Quick Summary:
- EIS Stands for Enterprise investment scheme
- You may be eligible to claim 30% income tax relief on investments
- An EIS scheme is a tax-advantageous way to supplement other long-term Investments
- You’ll potentially be able to defer paying capital gains tax on any realised gains
EIS Explained
An EIS share or fund is an alternative investment that involves shares in companies that have successfully qualified as EIS-compliant.
Investors looking to invest capital can benefit from considerable tax advantages – although they need to be conscious of the inherent risk in purchasing shares in early-stage companies that tend to carry a higher potential of failure than more established organisations or those with a stock market listing.
So what makes EIS so attractive to investors? The tax relief incentives.
EIS Tax Relief Incentives
The government launched the EIS to encourage greater investment in companies with excellent prospects but in need of capital to reach their potential to grow and contribute to the British economy.
Investors can claim income tax relief up to 30%, 100% tax-free investment asset growth, deferred capital gains liabilities, loss relief, and inheritance tax relief.
EIS Income Tax Relief
Income tax relief offsets an element of the risk linked with small business investment. It is available at 30% on investments up to £1 million per year, providing £300,000 of tax relief on income tax liabilities in the tax year the investment is made.
However, investors can also use EIS rules to support tax planning, with the option to treat the investment as made in the prior tax year, allowing double the maximum investment threshold by carrying back the first £1 million invested to the period before.
To qualify for full income tax relief, investors must retain their EIS shares for three years, and the company must remain eligible for the same period to avoid an HMRC clawback.
Tax-Free Growth of EIS Investments
If an investor decides to sell shares in an EIS company, the appreciation in share value is not taxed, which can be a sizable advantage given the pace at which early-stage businesses can expand.
The eligibility rules state that the investor must have claimed income tax relief and held the shares for three years or more.
Deferred Capital Gains on Share Disposals
Investors can defer gains subject to tax on the disposal of other assets by reinvesting the profits into EIS shares, with no maximum limit on the deferral value.
They only need to reinvest the gain rather than the entire sale proceeds to defer their capital gains obligation, and reinvestments must be made within one year before or three years after the original gain.
Capital gains tax is deferred until the investor sells the EIS shares, becomes a non-UK resident, or if the company becomes ineligible for EIS in the first three years.
EIS Loss Relief
If an EIS company fails or shares depreciate, the investor can claim loss relief, which reduces the overall impact on their portfolio – even if other EIS shares held by the same investor provide a profit.
You can read more about EIS loss relief here.
Inheritance Tax Relief for EIS Investors
EIS shares are eligible for Business Property Relief (BPR), enabling investors to leave shares to beneficiaries without an inheritance tax liability arising. They must have held the shares for two years or more for this tax relief to apply.
Want to know more? Read our full guide on the benefits of EIS here.
What type of companies can you invest in? Investment Opportunities Available Through EIS
An EIS-qualifying company isn’t necessarily an SME.
The eligibility rules state that compliant ventures must not have over £15 million in assets or more than 250 employees, and knowledge-intensive businesses within specific areas of activity have greater flexibility.
Many investors prefer specific sectors, company types, or industries based on their expertise and pre-existing knowledge. The positive aspect of EIS investment is that any profit-making business within the eligibility thresholds can become EIS registered.
While certain company structures are not permitted, primarily businesses dealing in share transfers, commodities, or land, many others can become EIS-eligible entities provided they are within the size and trading thresholds.
The outcome is a significant scope of business types, sectors, and industries, all of which may offer investment opportunities while retaining the tax advantages of the EIS scheme.
EIS Qualifying Knowledge Intensive Companies Explained
Knowledge-intensive companies allow a higher annual investment value of up to £2 million, doubling the potential income tax relief and providing opportunities for investors keen to engage in particular markets.
An EIS company must primarily conduct research and development activities to qualify as knowledge-intensive. For example, the EMVC Evergreen EIS fund allows for investment in early-stage life sciences, sustainable or industrial companies – all knowledge-intensive industries.
EIS knowledge-intensive investment funds need to invest at least 80% of all portfolio funds in verified enterprises focused on research and development or some form of innovation.
How to invest in an EIS opportunity?
Investors can purchase shares directly from an EIS-registered business or invest through an EIS investment fund, where a portfolio manager selects appropriate shares based on the investor’s objectives and risk exposure appetite.
Whilst direct investment can provide clearer visibility of the company’s activities and growth, there may be a greater likelihood of making a loss where investment isn’t diversified and is dependent on the success of one EIS-qualifying venture.
EIS fund investments provide a spread of investment assets balancing different sectors or businesses. While there is still the potential for one or more investments to fail, the broader impact on a diversified EIS fund is normally reduced.
The expertise and knowledge of the fund manager are essential. Although they will charge portfolio management and transaction fees, the prospects for an investor who wishes to reduce their risk or doesn’t have the time to conduct thorough research can be advantageous.
Benefits of Investing in EIS Shares or Funds vs directly
Like all investments, EIS-qualifying shares have risks and rewards, and every investor should ensure they have a comprehensive understanding of the potential to make a loss, as well as a gain, before putting capital at risk.
The benefits of EIS investment include the following:
- High growth potential investments, with early-stage businesses able to scale and grow faster than less agile larger organisations.
- Tax reliefs to offset some of the financial risks linked to EIS investment.
- Contributing to the future economy, financing innovative and ambitious companies, often with new takes on existing challenges.
- Diversification opportunities, with a range of business sectors and types to select from.
- Tax planning advantages, allowing high earners and those with larger tax liabilities to use EIS investments to reduce their overall tax obligations.
However, it is also essential to consider the potential drawbacks and areas where EIS investment may be a higher risk than a conventional share investment or listed company.
Who is the ideal EIS investor?
The Enterprise Investment Scheme (EIS) represents a high-risk investment alternative tailored for sophisticated, HNW investors who possess a forward-looking perspective and a keen interest in directly funding rapidly expanding British enterprises. This option is well-suited for individuals who don’t require immediate investment-generated income and are prepared to commit their funds over an extended duration.
EIS can be especially appealing to those seeking to defer taxes on capital gains resulting from business sales, manage substantial income tax obligations, or reinvest tax-exempt lump sums from pensions. This is due to the potential attractiveness of start-ups as an asset class under these circumstances. However, it’s vital to acknowledge that investing in start-ups inherently involves risks.
Understanding the Risks of EIS Investment
Investors put capital at risk when they invest in shares or an EIS fund, and there is a greater risk that the company may fail or that shares may drop to zero value.
While tax reliefs are generous, they rely on continued compliance and may be subject to regulatory or legislative changes which impact investors’ reliefs, eligibility, or access to capital gains tax deferrals.
Companies that lose their EIS status within the first three years of investment can result in investors being instructed to repay income tax relief without further reliefs available in subsequent periods.
Exit options are also limited, where selling unquoted shares is more complex, and it can be difficult to dispose of EIS shares following the minimum three-year retention period. Investors should treat EIS as a long-term investment rather than a short-term asset.
EIS Investment FAQs
Below we answer some of the most commonly asked questions about the EIS and the pros and cons for investors.
How Long Does it Take to Claim Income Tax Relief Following an EIS Investment?
EIS companies issue certificates called EIS3 forms to verify the investment, but it can take around six months to receive the documentation.
Investors can claim tax relief based on the date the shares are allotted rather than the date they invested, which will normally differ. Tax relief is claimable once the investor has the share issue certificate.
What Is the Maximum EIS Investment?
Tax reliefs apply on EIS investments of up to £1 million each tax year, doubling to £2 million for investments into knowledge-intensive companies or funds. Investors can invest more but are not eligible for higher income tax relief, although inheritance tax relief and capital gains tax deferrals apply to the full investment value.
You can read more about maximum EIS investment here.
What Does an EIS Carry Back Mean?
Investors can carry back some or all of their EIS investments to the previous tax year, effectively doubling the investment threshold in the current period and offsetting income tax from the prior tax year up to 30%.
However, if they have previous EIS investments, the threshold applies, so the carry back must be within the allowance for the tax year in question.
You can read more about EIS carry back here.
What Are the Average Returns on an EIS Investment?
Most EIS shares and funds provide returns based on capital growth rather than dividend disbursements, where investors benefit from the development of the company and the share value.
Companies or funds provide target yields to help investors make informed decisions, although a target is an aim rather than a guarantee. Average targets can range from 1.3 to ten times the capital invested, but the higher the target return, the higher the risk.
Can I sell my shares? How do I exit?
EIS shares aren’t traded on the stock market so you won’t be able to sell quickly to release equity as you would with regular shares.
Fund managers would work with you to formulate an exit strategy that facilitates the return of capital and any profits, tax-free or otherwise.
As with any investment, it’s important to know when you’ll exit and realise profits. This is why it’s discussed with your fund manager at the start of the investment. You’ll get a projected timeline and discuss common exit strategies that cover off scenarios like management buy-outs, trade sales, or refinancing. However, it’s important to understand that these approaches don’t come with any guaranteed outcomes.
Remember: EIS investments are designed for the long-term growth. To retain the income tax relief, there’s a mandatory holding period of at least three years.
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.