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Capital Gains Tax and the EIS: what you need to know as an investor
The Enterprise Investment Scheme (EIS) was introduced to encourage investors to support the next generation of British businesses. Buying shares in early stage companies, tax reliefs and incentives are offered 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 taxes, today I want to look at those related to Capital Gains Tax (CGT)
The EIS provides a number of reliefs and incentives for those investors with current or potential CGT liabilities, and they can generally be split the up into three areas.
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 and upon selling them they were worth £75,000, you would have no tax liabilities on that £25,000 gain. For other investments, this would normally be 28% of the gain - so for a £25,000 gain, it would be a £7,000 tax bill (assuming you had already used your CGT allowance).
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 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 do not need to have been from an EIS investment - they could have come from the sale of a property, for example.
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 is applicable when you dispose of your shares in the EIS-eligible company for a loss and you have held said shares 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, disposing of EIS shares at a loss allows you to claim loss relief on the remaining balance - after any income tax relief received has been accounted for - at the prevailing rate of 28%.
This means that if you invested £10,000 initially, and your EIS shares were then sold for £0 after three years, you could claim £1,960 in loss relief. This is 28% of £7,000, which is your initial £10,000, minus the £3,000 income tax relief.
Investing into EIS eligible opportunities
Investing in private, unlisted companies is a higher risk / higher return investment strategy and share values can decrease as well as increase (and you should always seek professional advice before making any type of investment). This was one of the main drivers that encouraged the government to introduce the EIS in 1993 (and its sister scheme, the SEIS, in 2012), attracting investment into riskier, early stage businesses by providing generous tax reliefs and incentives.
Whilst an investor into an EIS-eligible opportunity should have the primary focus of investing to support the business and drive forward growth, the tax reliefs and incentives are undoubtedly beneficial.
Whether it's income tax, Inheritance Tax or as we've mentioned here, Capital Gains Tax, many investors can directly impact on the amount of tax they have to pay (either temporarily or wholly) by making an investment into an EIS-eligible opportunity.