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.
An EIS share or fund is an alternative investment that involves shares in companies that have successfully qualified as EIS-compliant.
Investors can benefit from considerable tax advantages, although they need to be conscious of the inherent risk in purchasing shares in younger entities that tend to carry a higher potential of failure than more established organisations or those with a stock market listing.
However, 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.
Investment Opportunities Available Through EIS
Many investors prefer specific sectors, company types, or industries based on their expertise and pre-existing knowledge.
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 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.
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.
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.
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.
Comparing EIS Investment Opportunities
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.
Direct investment provides better visibility of the company’s activities and growth. Still, there is a greater likelihood of making a loss where an 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
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.
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.
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.
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.