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EIS tax reliefs: introducing carry back and maximising CGT disposal relief
We post a lot about the Enterprise Investment Scheme (EIS). That’s because we truly believe it represents a great opportunity to invest in early-stage businesses through an established scheme that offers you an accessible route into tax efficient investing.
We recently published a post that sets out how easy it is to claim income tax relief on your EIS investment. Just one of five tax incentives offered by investing through the EIS, in addition to income tax relief, your investments:
- Are exempt from Inheritance Tax
- Do not attract capital gains tax (CGT) if they have increased in value when sold
- Qualify for loss relief if they have decreased in value when sold
- Enable you to defer capital gains tax that you may have accrued following the sale of other investments
(each of the tax incentives are covered in our handy, free downloadable guide to the EIS)
Is the EIS too good to be true?
Given the immense benefits of investing into EIS, it's fully understandable that many question whether it's in fact too good to be true, and that there must be some hidden catch.
The reality is it's just a smart policy instrument.
Importantly, the tax reliefs are conditional, but today I want to give an introduction to two of, for many, the most used - and you may just be surprised to find that some of the technical conditions – such as ‘carry back’ – work in your favour.
Understanding EIS income tax relief
Your income tax relief is determined firstly by your level of investment:
- You are eligible to claim income tax relief on 30% of your investment. If you invest £1,000, you can claim £300 in income tax relief.
There are various conditions that affect your entitlement to income tax relief:
- You can claim a maximum of £300,000 EIS income tax relief within a single financial year. To reach this ceiling, you would have to invest £1,000,000.
- You must hold your investment for a minimum of three years. If you do not, your tax relief will have to be repaid.
- You must have paid sufficient income tax to claim back your tax relief. As a guide, in England, Wales and Northern Ireland in 2017/18 you would pay £2,700 income tax on earnings of £25k, £8,700 on £50k, and £28,700 on £100k. However, if you have capital to invest sufficient that your tax relief would exceed your tax paid, you can benefit from…carry back.
What is EIS relief carry back?
When you invest in an EIS-eligible opportunity, EIS relief carry back enables you to claim tax relief on income tax that you paid in the previous financial year.
Even if your EIS-eligible investments are modest, it can still be useful to carry back your tax relief to retain your full exemption for the current year (which, of course, can be used next financial year as well).
However, carry back really comes into its own if you make an investment that qualifies for relief that exceeds your income tax paid in the current financial year; see the worked EIS income tax relief example below:
"Vanessa is a solicitor. Her 2017/18 salary is £47,000 and she earned £44,500 in 2016/17. Vanessa recently inherited £40,000 and would like to invest this in an EIS-eligible business. This would entitle Vanessa to claim £12,000 in income tax relief. In 2017/18, Vanessa is scheduled to pay £7,500 in income tax; the level at which her income tax relief would otherwise be capped.
However, because Vanessa also paid £6,800 in income tax in 2016/17 (and has not previously claimed any tax relief against that payment) she can add this to her £7,500 to give a total of £14,300 against which she can claim. This is enough for her to claim her full entitlement of £12,000 tax relief on her £40,000 investment."
Understanding EIS capital gains tax relief on disposal
Most asset classes attract capital gains tax if you sell your investment for more than you paid for it. Everyone has an annual CGT-free allowance; this is £11,300 in 2017/18 and tends to rise incrementally on an annual basis.
If you have a modest investment portfolio, achieving capital gains that exceed your annual CGT-free allowance might be unlikely.
However, if you have a more significant investment portfolio then you will face CGT at anywhere between 10% and 28% (depending on your income and the asset class). See the worked EIS tax relief example below:
"Balvinder invested £250,000 in a FTSE 100 company in May 2013. He is preparing to sell this investment for £325,000 in September 2017. This will present Balvinder, a higher-rate taxpayer, with a CGT liability of £12,740 having exhausted his CGT-free allowance.
Had Balvinder instead invested in an EIS-eligible company, he could have benefited from initial tax relief of £75,000 and his capital gain would have been tax free without impacting on his CGT-free allowance."
Achieving capital gains tax efficiency through dispersed EIS investments
As demonstrated, capital gains tax relief at the point of disposal is a valuable part of what EIS investments offer.
One important element to this is that CGT exemption on EIS investments can only be realised if you have claimed income tax relief on the initial investment. You do not have to have claimed your full 30% entitlement to achieve eligibility.
If you make EIS investments that entitle you to income tax relief that exceeds your income tax paid, it is in your best interests to claim some of the tax relief available across all investments, rather than all the tax relief available for some and none for others.
"Maurice is a retail manager. He paid income tax totalling £5,850 in 2012/13 and 2013/14 combined. Having inherited £30,000, Maurice made three EIS investments of £10,000 each and would have been entitled to tax relief of £9,000.
Although his tax relief is capped at the £5,850 he paid, he should ensure that he claims £1,950 across each investment, and not £3,000 on the first, £2,850 on the second, and £0 on the third. Claiming income tax relief on all three will ensure that any capital gains that they achieve will be exempt from CGT and returned to Maurice in their entirety."
Sometimes the headline benefits of an investment opportunity can obscure some less appealing small print. This is not the case with the EIS - the more we find out about EIS, the better it gets.
And whilst investing time understanding how the various tax efficiencies work is always recommended, the reality is that the Enterprise Investment Scheme offers some of the most generous tax reliefs currently available in the UK.