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Income tax relief and the EIS: what you need to know as an investor

One of the UK's most popular tools for investing into early stage companies, the Enterprise Investment Scheme (EIS) has long been renowned for the generous range of EIS tax reliefs it offers investors - perhaps the most well known being income tax relief.  

Offering 30% income tax relief for investments into EIS-eligible companies, EIS income tax relief has the potential to significantly reduce investor tax bills, and in doing so minimise the risk associated with investing into startups and scaleups - a feature accentuated by its additional role in loss relief. 

This ability to reshape tax liabilities and minimise investment risk (all the while accompanying the high growth potential and impact investing benefits that EIS investments can bring), has made income tax relief among the most notorious of its kind in the UK venture capital space.

 

What is income tax?

Before we jump into the tax reliefs and incentives, it’s worthwhile just reiterating what income tax is. Most will be aware it’s the taxation we pay to the HMRC through either PAYE (pay as you earn), which is deducted at source by your employer from your salary, or is accounted for annually in a personal tax return.

However, income tax isn’t exclusively paid on the salary you receive from an employer, other streams of capital can also be liable to it, including:

  • a number of state benefits
  • most pensions, including state pensions, company and personal pensions, and retirement annuities
  • rental income
  • certain job benefits and perks (including monetary bonuses)
  • income from a trust

With everyone having a personal allowance of £12,570 (as of the 2021/22 financial year), the three current rates of income tax are basic rate (£12,571 to £50,270, charged at 20%), higher rate (£50,271, to £150,000, charged at 40%) and additional rate (over £150,000, charged at 45%).

As such, being able to realise tax reliefs in any form for most can be extremely beneficial. And if they come as a result of an investment into an impact driven company that you truly believe in, all the better.

 

So what EIS income tax reliefs are available?

There are two clear ways in which an investment into an EIS-eligible opportunity can reduce income tax liabilities: through direct income tax relief and loss relief.


Income Tax Relief

For an investor into the EIS, income tax relief of up to 30% can be claimed on investments. Generally speaking this is up to £1,000,000 in one tax year and with a maximum tax reduction in any one year of £300,000, provided you have sufficient income tax liability to claim the relief against.

This maximum investment allowance doubles from £1,000,000 to £2,000,000 should all capital over the original threshold be invested into knowledge intensive companies (companies actively pursuing research, innovation or development at the time of issuing shares).

Providing income tax eligibility is met, this effectively means high net worth investors have the potential to deduct £600,000 from their income tax bill per year.

In practice, your investment can be reduced immediately by 30%, claiming tax relief on the income tax you have paid. For example, if you buy shares in an EIS eligible opportunity for £20,000, and you have a £10,000 income tax bill to pay, your EIS investment could see this bill reduced by £6,000 (30% of £20,000).

The main remits for this relief are that you must have paid sufficient income tax against which to claim tax relief, and you must hold the shares for a minimum of three years from the date of issue or commencement of trading, whichever is the latest. Should you claim the tax relief at the point of investment, but sell the shares within the three years, the obligation is there to repay the relief in full.

Interestingly, the income tax relief can be claimed in the tax year within which the investment has taken place, but it can also be carried back to the previous tax year. Consequently, if you find yourself with a large income tax liability at the end of the 2021/2022 financial year, an investment made in 2020/2021 could be deferred and retrospectively claimed.

 

Loss Relief

The loss relief available through EIS investments can also be directly linked to income tax, and is one which can be considered as being bittersweet. One would hope that the company you purchase shares in will go on to be a huge success and produce a brilliant return on your investment.

However, should the company dissolve and the shares no longer hold any value, you can claim loss relief on your income tax liability and see a potential benefit in this way.

Loss relief on income tax is calculated by multiplying the net loss by the rate at which an investor pays income tax.

By way of an example, Fred buys £20,000 of shares in Company A. He claims 30% income tax relief up front and consequently reduces the ‘net cost’ of the investment to £14,000.

Four years after the shares were purchased, Company A dissolved and the shares became worthless. Being a higher rate taxpayer, Fred pays income tax at 40%, and consequently is able to claim loss relief on his effective loss of £14,000 at 40%, equalling a total loss relief of £5,600.

Coupled with his £6,000 income tax relief, this bring’s Fred loss to £11,400, and not his full £20,000 investment amount.

Loss relief is in situ as investing in private unlisted companies is a high risk / high return investment strategy, and share values can decrease as well as increase. As long as you’ve held the shares for three years, then an allowable loss may arise.

This loss can be applied in the current tax year, or indeed carried forward and set against future income tax liabilities - or importantly, against capital gains tax liabilities (but not both).

Download the Free EIS Investors Guide

 

A point to note on dividend income tax

EIS investments are not exempt from tax on dividend payments. However, it’s generally expected that in an early stage business where any profit or surplus working capital is realised, it will be reinvested into the company to further fuel their growth and promote the best possible exit value for the founders and investors.

 

Investing into the EIS and benefitting from income tax reliefs

By investing into EIS-eligible opportunities, investors can support the next generation of British businesses, being a driving force behind a transformational early stage company whilst benefiting from high growth potential as well as advantageous tax benefits. 

Though tax reliefs such as EIS income tax relief can help minimise the risks associated with investing in early stage companies, the full risk profile of any EIS investment (and credibility of its provider) should always be considered before making any investment.

 

 

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Creating Value.
Delivering Impact.

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Growth Capital Ventures (GCV) is backed by funds managed by Maven Capital Partners, one of the UK’s leading private equity and alternative asset managers.