Capital Gains Tax and the EIS: what you need to know as an investor
The Enterprise Investment Scheme (EIS) was introduced in 1994 to encourage investors to support the next generation of British businesses, and since that point more than 33,000 early stage companies have benefitted from the scheme.
Offering investors The opportunity to purchase shares into early stage companies whilst providing a range of generous tax reliefs, the EIS has become increasingly attractive to the UK's venture capital space over the past two and half decades, in part due to its ability to help mitigate some of the risk involved when making investments into high growth SMEs.
With the reliefs and incentives spreading across a number of tax categories, one of the key features the EIS boasts is an ability to reduce and rework an investors capital gains tax (CGT) bill, doing so via three main routes.
1. Tax-free capital gains
An incentive rather than a relief, providing shares in an EIS-eligible company are held for a minimum of three years (from either the date of issue or the commencement of trading, whichever is later), no Capital Gains Tax is payable on any profits at the point of disposal.
This means that if you invested £50,000 in an EIS-eligible investment opportunity, and upon disposal your shares were worth £75,000, you would have no tax liabilities to pay on that £25,000 gain.
With the current rate of capital gains tax in the UK sitting at 20% for higher and additional rate taxpayers (or 28% in the case of property sales), this tax relief alone would result in a saving of £5,000 in capital gains in this case (or £7,000 when compared to the same gain made in a property sale), assuming you had already used your annual CGT allowance of £12,300.
Shares can of course be held for longer than the three year qualifying period. If this is the case and the company you have invested in continues to grow, your CGT free gains may accrue over a longer period - but this doesn't affect your position and the gains will be exempt from CGT.
2. Deferral relief
One of the two CGT reliefs available from investing via the EIS, deferral relief essentially provides you with the ability to defer the tax liability of a capital gain (arising from the sale of any other asset) by investing that gain into an EIS-eligible opportunity.
Available for qualifying UK investors who may have realised capital gains over the last 36 months or are anticipating gains over the 12 months following investment, importantly, these gains can come from the sale of a range of assets, from property, to art, to shares external to the EIS that are usually liable to CGT.
By way of an example, let's say you had sold a commercial property and had made a £100,000 capital gain. On the assumption you had already used your annual tax free allowance, you would be liable to pay £28,000 in CGT (based on the current rate of 28%).
However, if you invested the £100,000 capital gain into an EIS-eligible business, that £28,000 CGT liability wouldn't need to be realised until the point at which you disposed of your shares.
An unlimited relief, CGT deferral relief has no upper limit and it's open to all investors (both individuals and trustees), regardless of whether their interest in the company exceeds 30%. Investors must generally be a UK resident, although in some circumstances it may be available to trustees of "certain settlements".
3. Loss relief
The second of the two CGT reliefs available from investing into EIS-eligible companies, loss relief can be claimed should an unexpected event arise with your portfolio company that results in you disposing of your EIS shares at a loss (should they have been held for at least three years).
Interestingly, loss relief can be claimed against both income tax and capital gains tax, but looking specifically at the latter, when disposing of EIS shares at a loss investors are able to calculate loss relief by multiplying their effective loss (the value originally invested minus the return realised and) by their marginal rate of capital gains tax.
For example, this would mean that should you invest £30,000 in an EIS eligible company and realise just £20,000 in returns upon disposal, you could then multiply your effective loss of £10,000 by your 20% rate of CGT (should you be a higher or additional rate taxpayer) and claim a further £2,000 back in loss relief.
Investing into EIS eligible opportunities
Whilst the EIS's capital gains tax reliefs can mitigate a proportion of the risk associated with investing in startups and scaleups, investing in private, unlisted companies is a higher risk/higher return investment strategy and share values can decrease as well as increase (so you should always seek professional advice before making any type of investment).
One of the key drivers that encouraged the government to introduce the EIS in 1994 (and subsequently its sister scheme, the SEIS, in 2012), the ability of tax efficient investment schemes to fuel growth into some of the UK's most transformational young SMEs - whilst offering significant simultaneous benefits for investors - continues to be a key factor in the scheme's popularity among UK experienced investors today.