EIS deferral relief: how can you benefit as an investor?
Approaching its 30th year of operation, the Enterprise Investment Scheme (EIS) is among the most established venture capital schemes the UK has to offer, its popularity having catapulted over the last few decades in part due to the host of generous tax reliefs it offers investors.
Helping to stimulate investment into the next generation of British businesses, it's generally considered one of the most beneficial tax efficient investment schemes out there for startups and investors alike.
If you know about the EIS already, chances are you'll be aware of arguably the most notable of the EIS tax reliefs - 30% income tax relief
But if income tax relief is one of the most notable reliefs the EIS offers, at the other end of the spectrum sits EIS deferral relief - a lesser known relief that in fact can be just as powerful to investors as its better known counterparts.
EIS deferral relief is one of scheme's reliefs directly relating to Capital Gains Tax (CGT).
In essence, when you dispose of an asset that falls under the umbrella of CGT liability, should you have exceeded your CGT allowance (currently £12,300 for the 2021/2022 tax year), CGT will be applicable to any gain made on the asset you've disposed of.
Let's use an example of an individual who's an additional or higher rate tax payer, and who has sold an asset, making £100,000 in the process (and who has already used their CGT allowance).
On this £100,000 gain, that individual would be due to pay 20% in CGT. This effectively means handing over £20,000 to HMRC in the tax year relating to the gain.
With EIS deferral relief, they can defer this entire gain (or part thereof) - and therefore the payment of tax on it - to a period in the future.
How do you benefit from EIS deferral relief?
The main assumption of EIS deferral relief is that to benefit, you must invest all or part of a gain into an EIS eligible investment opportunity (with the amount invested being that which the amount you can subsequently defer is calculated from).
A particularly interesting feature about this relief is that an investor does not need to make a CGT gain before they make use of EIS deferral relief.
As per the HMRC guidance:
The EIS shares you subscribe for must be issued to you in the period beginning 12 months before, and ending 36 months after, the date of the disposal for which you wish to claim relief.
What's more, HMRC explain "We have discretion to extend these time limits", which suggests an even greater period of EIS share acquisition could be possible.
In addition, the latest date for making a claim is five years after the first 31 January after the tax year in which the shares were issued. This means you can, in theory, have over eight years within which to make a claim further to incurring the CGT-liable gain.
It is important to understand, however, that you cannot make a claim for deferral relief until you hold the appropriate EIS3 certificate, issued further to purchasing shares in an EIS-eligible company.
The primary focus of EIS deferral relief is to pay the bill at a later date
With numerous tax reliefs available when investing in EIS, the easiest way to understand deferral relief's role is that it offers investors the opportunity to pay a CGT gain at a later point in time.
Therefore shouldn't be considered a relief that can reduce a CGT gain, or even write it off completely, but a relief that allows you to not pay tax on the gain within the financial year it would traditionally be due.
Whilst this means you would still be expected to pay, in the above scenario, £20,000 in CGT at a later date, an investment in EIS could reduce the impact of this on your financial situation.
For instance, if you invested £100,000 into EIS shares (so to defer the £20,000 CGT bill) and your shares doubled in value three years later, you could sell and make a £100,000 profit - a profit (or 'gain') that would not be liable to CGT, as returns on EIS investments are CGT exempt.
Therefore, whilst your deferred £20,000 CGT bill would be due upon selling your EIS shares, you would have £100,000 that could effectively be used for this, giving you an £80,000 net return from the investment process.
What's more, should you choose to then invest the gains realised from this EIS investment into another EIS-eligible investment opportunity, the original gain will continue to be deferred, in theory opening up the possibility of deferring the CGT bill indefinitely should the process be repeated.
(It is important to point out the above scenario is a very generic one and doesn't take into account any of the other tax reliefs, or any specific taxation stipulations you may need to abide by).
Investing into EIS eligible opportunities can provide a vast array of benefits. Tax reliefs are numerous and are provided to help mitigate the risks associated with investing in early stage startups.
With EIS deferral relief an effective example of how beneficial the tax reliefs can be for experienced and high net worth investors especially, the result of investing into EIS opportunities can evidently extend far beyond the immediate 30% income tax relief you can achieve.