8 reasons EIS is still a popular investment scheme 25 years on
Having been around since 1994, the Enterprise Investment Scheme (EIS) is a long-established part of the UK tax and investing skyline.
In the years since its launch, it has been a lifeline for startups, encouraging over £18bn worth of investment into early stage, emerging businesses.
Numerous other tax incentives have come and gone with the passing of governments and chancellors, but the EIS has remained in place.
So what is the secret of its its longevity?
1. Generous income tax breaks
At the heart of the EIS scheme is a highly appealing income tax break for investors.
Those who back an EIS-eligible company will receive income tax relief worth 30% of the value of their investment.
Eligibility comes down to various factors – including the size of the company, since the scheme is designed to support high growth, high risk opportunities in the startup space.
Businesses must have less than 250 full-time staff and gross assets worth no more than £15m. As well as having a permanent UK base, the company must not be listed or planning to list on any stock exchange.
Certain trades do not qualify, however. Among them are legal and accountancy services, hotel and nursing home operations, farming, and coal and steel production. Such industries do not generally match the EIS’s remit of supporting rapidly growing market opportunities.
In any given year, investors can put up to £1m into one or several startups, meaning the tax break is worth up to £300,000 - but bigger rewards are available by supporting what HMRC calls “knowledge-intensive” enterprises.
2. Double boost for knowledge investors
From April 2018, a new EIS rule was introduced that raised the annual investment allowance to £2m for certain opportunities.
It means that any investors injecting funds into “knowledge-intensive” businesses, which the government deems vital to the future UK economy, now have twice the normal annual allowance.
As long as £1m of their yearly EIS investment is in these knowledge-driven firms, they can benefit from up to £600,000 in income tax relief.
3. The seed success story
The continued popularity of EIS may partly be attributed to the impact of its younger sibling, the Seed Enterprise Investment Scheme (SEIS). This is designed to encourage investment for businesses in their earliest stages.
By investing in companies in qualifying trades that are less than two years old and have assets worth under £250,000, investors can receive a 50% income tax break.
With a maximum investment limit of £100,000 per year, the scheme offers the equivalent of a £50,000 annual income tax reduction.
It could be argued that its influence on the wider popularity of EIS may be two-fold.
Firstly, it is creating the successful startups of tomorrow, by helping them past the most challenging early days in business and giving them the ability to scale up. This means a healthy pipeline of EIS-ready opportunities is being created.
Secondly, SEIS is a fantastic introduction to startup investment, which can be daunting given the high-risk nature of many enterprises. The considerable tax break helps to offset risk and ease newcomers into angel investment. From here, they may look to make bigger investments in EIS companies.
4. Wealth transfer benefits
Although perhaps a gloomy consideration, inheritance tax (IHT) is an important issue for sophisticated investors. Last year HMRC collected more than £5.2bn in IHT, almost double the amount generated in 2010.
Generally, IHT is paid at a rate of 40% on everything that exceeds the personal estate tax-free threshold of £325,000.
But EIS investments are exempt from IHT, as long as they have been in place for at least two years – a considerably shorter period than many other asset classes. Also, EIS assets remain in the investor’s control for the rest of their life, rather than being transferred to the immediate control of beneficiaries.
EIS investing can therefore ideal for individuals keen to transfer their wealth to loved ones while minimising its tax liability.
The 30% income tax relief on EIS investments can be claimed for the year of investment or the previous tax year. This added flexibility, although a relatively minor plus point to some, may be important for many investors.
For example, if they recently exited their business and have a large amount of capital to invest, they could take advantage of both the previous and current year’s EIS allocation.
Anything that delivers flexibility from the taxman is welcomed by investors.
6. Gains relief
One of the biggest draws to startup investing is the prospect of lucrative returns, perhaps via a trade sale or takeover.
An extra incentive for EIS investors is the fact that their profits from such events won’t be swallowed up by capital gains tax (CGT). As long as the shares have been held for at least three years, any capital gains they generate are CGT exempt.
Also, any capital gains made from the disposal of any other assets can avoid CGT liability by being invested into EIS opportunities.
7. Added protection
EIS is designed to reward investors who accept the relatively risky nature of startup investment. While income tax relief goes some way towards mitigating these risks, further protection comes via loss relief.
If a business you have invested in fails, you will receive loss relief to soften the blow. This is calculated by factoring in your tax bracket and the amount of your capital deemed to have been at risk.
For example, if you had invested £100,000, but claimed £30,000 in income tax relief, £70,000 would have been at risk and subsequently lost in the startup’s failure. If you are an additional rate (45%) taxpayer, your loss relief would be worth 45% of £70,000 – or £31,500.
8. A door to the many other advantages of startup investment
Beyond the various tax implications of EIS, the wider benefits of startup investment keep investors flocking to the scheme.
Startup investment is relied upon to bring diversity to portfolios that may otherwise be populated by stocks and shares or property. Multiple startups spanning multiple sectors can increase the growth potential of portfolios and lessen their exposure to risk.
Furthermore, startup investment via the EIS enables seasoned investors to share their knowledge and expertise. Particularly if you invest in a sector you know well, or after your own entrepreneurial journey, you could have valuable insights to share with the company’s founders. Therefore, you can directly influence the outcome of your investment.
Also, your investment could be supporting innovation and job creation. The satisfaction that this brings, combined with the many financial advantages, makes EIS a highly attractive option for investors.