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Note: the following guide is not intended to serve as investment advice, but rather as guidance around how tax works for a specific type of investment.
In the UK, some new businesses struggle to attract the money they need to get off the ground. Some can secure loans or other forms of finance, but many rely on support in the form of private investment.
Private investment provides funds to businesses in exchange for shares. These funds are used to grow the business through various means such as acquiring new equipment, hiring new employees, launching a new product, etc. The government supports private investment through the Enterprise Investment Scheme, or EIS, which allows investors to claim considerable tax relief on investments made in eligible companies.
The ethos of the scheme is to encourage investors to support small UK businesses. The relief options help mitigate some of the risks associated with start-up enterprises, as many of them may struggle or fail even after securing investment.
If you’re considering investing in small businesses, or you’re considering expanding an existing portfolio, understanding how EIS tax relief works will help you make more informed decisions around your finances.
Why invest in EIS-qualifying businesses?
The EIS offers investors the opportunity to support small, growing businesses which have the potential to surge in value. To offset the risk of things going wrong, HMRC offers generous tax reliefs on these investments, which makes it an appealing proposition for investors.
Criteria for EIS investments
A business must be EIS-qualifying in order for investors to claim EIS tax relief. The government uses the EIS designation to focus funding on certain sectors, so what is or isn’t EIS-qualifying can change over time.
In general, EIS-qualifying companies must be small trading businesses that are unquoted on any stock exchange. They must have been trading for less than seven years, or 10 if classed as knowledge-intensive. The business must be permanently established in the UK, with a workforce of less than 250 employees and less than £15m in gross assets before your investment, or £16m after it.
Certain business sectors are excluded from EIS, including:
- Forestry, farming and market gardening
- Operating/management of hotels and care homes
- Legal and accountancy services
- Energy generation
- Coal, steel and shipbuilding
- Land acquisition, property development or leasing
- Dealing in goods other than normal retail or wholesale distribution
When you choose to invest in an EIS-qualifying business, you must purchase new shares rather than existing ones. Your funds must be used within 24 months by the business to drive growth. Investments can’t be used to cover ongoing costs.
Businesses can only raise £5m per year annually through EIS, with a lifetime cap of £12m. While these numbers may seem significant for small, start-up style businesses that EIS applies to, the tax benefits for investors make it an appealing option.
What EIS reliefs are available
If you choose to invest in an EIS-qualifying business, you can access a range of different tax reliefs (collectively known as EIS tax reliefs). The most commonly-discussed relief is related to income tax, but there are other tax benefits around monies gained or lost through the investment itself.
Shares must be held for three years in order to gain full access to all relevant reliefs. Some can be accessed earlier, but if you dispose of shares within three years, you may have to repay reliefs to HMRC.
The tax reliefs associated with EIS are as follows:
Income tax relief
If investing in an EIS-qualifying business, you can access up to 30% in income tax relief. You can claim this 30% relief on investments up to £1,000,000 in a single tax year, which could potentially mean a maximum tax saving of up to £300,000 if you have sufficient income tax liabilities.
Some companies are classed as Knowledge Intensive Companies (KICs), which is an HMRC categorisation that applies to businesses that carry out research, development and innovation. If the EIS-qualifying business you’re investing in is classed as a KIC, you can invest a further £1m and benefit from 30% tax relief on a total of £2m in a tax year.
However, you must hold shares in the company for three years and the company itself has to remain EIS-qualifying for that time. If either of these things changes, you may have to pay the tax relief back to HMRC.
EIS gains relief
As a shareholder, you are entitled to sell off your shares. If you sell them at a profit, any gains made over your original purchase price are 100% tax-free. This can be highly lucrative as some small companies may experience significant share growth before you sell. To qualify for this relief, you must have already claimed income tax relief as described above.
Capital gains tax relief and deferral
If you make gains on the sale of other assets you own, you can reinvest the gains in EIS shares. This allows you to defer the gain indefinitely, provided the money stays invested through EIS.
To qualify for this relief, you must reinvest either 12 months before you make the gain or three years afterwards.
Inheritance tax relief
All investments in EIS-qualifying companies that have been held for at least two years at the time of death will be eligible for 100% relief from inheritance tax.
Loss relief and its impact on investments
EIS-qualifying companies are not certain investments. Capital is at risk and sometimes you’ll make losses. To offset this, HMRC allows EIS investors to offset any loss, minus income tax relief, against your income tax bill. This can be a powerful way to recoup losses, as you can deduct the loss from your taxable income to drive down your tax bill.
How to claim EIS tax relief
Claiming EIS tax relief is easier than you might think, provided you’re making investments in line with what we’ve already discussed. Before you start a tax return, make sure you have the EIS3 certificate from any EIS-qualifying company you’ve invested in, which details the company name, the amount invested and the date of the share issue.
In most cases, you don’t need to provide the certificate itself – you just need the information on it. Once you’ve acquired it, you’ll have to fill out a tax return either by paper or digitally. Most people use the online Self Assessment platform to make things simple. The process is as follows:
- Log in to self-assessment and begin as normal
- In section 3 “Tailor your return”, there’s a question about claiming ‘other tax reliefs’. Answer yes.
- Fill out the information requested in section 4, which asks for the total amount of EIS-qualifying investments you wish to claim tax relief on.
There are other ways to claim, such as through an EIS claim form - which is often used when trying to claim for previous years.
It’s important to get things right when claiming such a significant tax relief. When in doubt, speak to an expert accountant here at Crunch and we can help you make the right decisions.
EIS alternatives
EIS isn’t the only scheme that encourages private investment. There are also Venture Capital Trusts (VCT), which offer similar income tax reliefs of 30% on the value of new shares – though this is capped at £200,000 per tax year.
The Seed Enterprise Scheme, or SEIS, is similar to EIS but focuses on even smaller businesses at the earliest stages. Due to the higher risk of investment in new businesses, SEIS offers tax reliefs of up to 50% but the amount you can fund is capped at £100,000.
The future of EIS tax relief
EIS reliefs are currently due to expire in April 2025, though the government has made it clear there is an intention to extend the scheme past this date. With recent figures indicating over £30bn of investment has been given to UK businesses through EIS and SEIS, it seems unlikely that EIS will end within the next few years.
However, as recent political turbulence has shown, there is no certainty around this topic. If you’re concerned about tax reliefs and how to manage tax on your investments, speak to the team here at Crunch to get support.
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