What is EIS Investment? EIS Schemes Explained – Definitions and Meaning

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. Capital gains deferral is also referred to as reinvestment relief – with any reinvested profits eligible.

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.

If the investor gifts or sells their EIS shares or the shares themselves become ineligible for EIS tax reliefs due to a change in the size, structure or characteristics of the company, any deferred capital gains tax will become payable at the prevailing tax rate.

We discuss EIS reinvestment relief in more detail here, should you wish to learn more.

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.

Investors can claim EIS loss relief based on the amount invested, less any income tax relief they have already claimed, normally based on 30% of the invested funds. Should EIS shares drop in value or lose all value if the company fails, this tax relief mitigates the impact and lessens the overall capital loss.

Note that loss relief is not available to cover the financial loss entirely. Instead, it is calculated at the investor’s marginal income tax rate – effectively reducing the net loss by up to 45%.

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.

The outcome is that EIS inheritance tax relief can provide tax efficiencies of up to 40% against the value of shares within an investment portfolio – without any restrictions on which heirs or beneficiaries you choose to leave your shares to.

However, if a recipient receives EIS shares from an estate, the shares will be valued at the point of transfer. Some tax reliefs, such as capital gains tax, may be payable if the shares subsequently appreciate or the inheritor sells the shares at a profit against the transferred value.

Want to know more? Read our full guide on the benefits of EIS here.

EIS Advance Assurance Status 

One of the topics often misunderstood by prospective EIS investors is the relevance of ‘Advance Assurance’ – a status granted by HMRC in advance of a capital raise. The important factor is that although Advance Assurance verifies that the tax office has not concluded, preliminarily, that a company will be disqualified from applying for the EIS, it is not a guarantee.

In short, companies apply for this status to present a positive picture to investors and to EIS funds. Most angel investors considering possible EIS investment opportunities will not consider a business that does not have Advance Assurance, but it may not be possible for a company to guarantee with 100% certainty that it will go on to become a registered EIS-eligible business.

The Place of EIS Advance Assurance in Investment Risk Analysis

As a general rule, it is preferable to subscribe to a capital raise with a company with Advance Assurance than without, noting that businesses will typically need to raise investment and then confirm that the invested capital qualifies for EIS tax treatments.

While this may appear to be a slightly ‘catch-22’ scenario, the alternative investment option, choosing to invest via a fund or established portfolio, carries less risk since there is a reduced potential that any company within a fund will be found to be ineligible for EIS status after raising finances through a share issue.

Rather than acting as a certainty, Advance Assurance informs investors that HMRC has given positive approval to an initial application. It is, therefore, more likely to approve an EIS application, provided nothing about the company, its trading history or the specifics of the capital raise change in the interim.

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 sciencessustainable 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.

Investing in EIS vs SEIS Companies or Funds

The Seed Enterprise Investment Scheme (SEIS) is similar to the EIS in its objectives – but focuses on a different category of early-stage investment and has variable risks and rewards.

Much as the concept of the EIS is to encourage private investment into unlisted businesses or funds, the SEIS provides favourable tax treatments in return for capital investment. To be eligible for the SEIS, however, a company can have a trading history of up to three years, with a maximum of 25 employees.

Financial thresholds include a maximum of £200,000 in business assets and a cap on capital raises of £250,000, which the organisation needs to invest or spend within a three-year period.

To counteract the greater risk of investing in a business that is less than three years old, the government provides higher tax reliefs. The downside is that the investment limits are also lower, which means the tax relief from a proportional perspective is higher, but monetarily is also limited.

EIS vs SEIS Tax Reliefs

Investors can claim a generous 50% income tax relief against funds invested into a SEIS-eligible enterprise but have a maximum annual investment cap of £200,000.

Therefore, the highest income tax relief claimable is £100,000, compared to £600,000 against investments into KIC-qualifying EIS companies.

You can explore the contrasts between these venture capital schemes in our separate comprehensive guide to the EIS vs SEIS.

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.

Click here to learn more about the EIS rules and how these may apply to your investment portfolio or planned EIS investments.

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.

However, most EIS firms will have proceeded through the Advance Assurance HMRC assessment process, which means that shares available to investors have a good likelihood of qualifying for the EIS.

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.

To be eligible for the full range of tax reliefs, investors must put capital at risk. Any risk-mitigation mechanism or agreement that precludes a loss against EIS shares will disqualify the investor from tax relief. We’ve explained the EIS risk to capital condition in more depth if you need clarity about which share features might be considered a breach of the rules.

Will the scheme continue beyond 2024? A history of the scheme

The confirmation from the Chancellor that the EIS will continue past its original ‘sunset clause’ date provides the peace of mind that investors will be able to benefit from tax treatments and EIS allowances long into the future – but this is far from the first time the EIS has been reformed.

The scheme was originally established in 1994 by the UK government, while capital gains tax relief was not introduced as a scheme element until 1999. In the interim, there have been various changes and reforms, including revisions to the requirements for a business to be recognised as a qualifying trade.

There are a total of three venture capital schemes available, including the EIS, the Seed Enterprise Investment Scheme (SEIS) and the Venture Capital Trust (VCT) initiative. The previous Social Investment Tax Relief scheme was closed to new investments from the start of the 2023/24 tax year.

EIS Investment FAQs

Below we answer some of the most commonly asked questions about the EIS and the pros and cons for investors.

How Do I Choose Between One EIS Investment and an EIS Portfolio?

Investors can choose to invest in the EIS either via a direct investment into an individual company with EIS status or by investing in a fund or portfolio of EIS shares that is managed by a designated fund manager.

Single-company investment provides control, allowing the investor to pick a specific company they would like to invest in. The corresponding risk is that returns are wholly dependent on the performance of that one company.

The alternative of investing in a fund provides diversification by geography and trading sector and has the benefit of a professional fund manager making decisions about which investments align with the fund’s objectives. However, there is no guarantee that every selected company will achieve its targets, nor that this lower-risk investment will always result in a positive return.

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.

What Is the Three-Year Rule in EIS Investment?

We’ve noted that the minimum retention period for any EIS shares or fund shares is at least three years. If an investor decides to sell shares before this time or otherwise disposes of them, any tax reliefs they have claimed can be clawed back by HMRC.

The guidance is to consider an EIS investment as medium to long-term since there would be little advantage in investing if you expect to transfer your shares and relinquish all of the advantageous tax reliefs and treatments.

Our explainer covers the three-year rule in EIS in greater depth, including some more complex scenarios, such as the impacts on investors of company closure within three years of a share issue.

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 long-term growth. To retain the income tax relief, there’s a mandatory holding period of at least three years.

How Can I Claim EIS Tax Relief?

Tax relief is not applied automatically, nor will HMRC apply other reliefs, such as capital gains tax deferral, unless you actively apply for the allowable tax treatment. The first step is to ensure you have a copy of your share certificate, which will be either:

  • An EIS3 certificate for direct company share purchases.
  • An EIS5 certificate for fund shares.

Without a share certificate, you will be unable to claim any tax relief – it is common for the share issue date to be slightly delayed while the company completes the raise. Investors should also have a separate certificate for each individual investment; you cannot ‘pool’ your EIS portfolio without having proof of the invested funds.

The next phase is to complete the relevant claim form or include details of the tax relief you wish to claim on your self-assessment tax return. If you are not due to submit a tax return in the near future or need to claim tax relief and don’t normally submit a tax declaration, the step-by-step information in our guide to claiming EIS tax relief will walk you through the appropriate process.

Will There Be Any Changes to the EIS in the Next Tax Year?

Any government-backed initiative does, of course, have the potential to change – and there is a possibility that the tax reliefs offered, the rules for investors or the eligibility criteria may be adjusted. Originally, the scheme was expected to end in 2025, although it has since been renewed indefinitely.

Our guide published at the start of this tax year gives some insights into the government’s position on the EIS and SEIS and earlier adjustments made.

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