Should EIS investments form part of your portfolio?
When it comes to investing, everyone has different goals and needs. That being said, there are many reasons why investing in companies via the Enterprise Investment Scheme (EIS) can be beneficial:
- Generous tax reliefs
- Potential for lucrative tax-free returns
- Portfolio diversification
- Positive impact
However, investing in early-stage EIS-qualifying businesses, either directly or via an EIS fund, is a higher risk and higher return investment strategy. If you're an experienced investor looking to add something different to an already well-balanced investment portfolio, EIS-eligible investment opportunities can provide further portfolio diversification and provide access to a range of generous tax reliefs.
As an HMRC-approved scheme, the EIS provides you with a range of tax reliefs which can help to minimise potential downside risk and maximise potential returns. To benefit from these tax breaks, certain conditions must be met. For example, you need to hold EIS shares for at least three years to obtain income tax relief, and the investee companies need to remain qualifying. It's important to note that this is a brief overview and does not cover all of the conditions. EIS rules can change and tax benefits depend on your personal circumstances.
Here's an overview of the main tax reliefs:
Generous Tax Reliefs
- Income Tax Relief - Up to 30% – If you invest £100,000, you could save up to £30,000 on your income tax bill for that year. To be eligible for this tax break, you must have a sufficient income tax liability and hold the shares for at least three years. Investing in EIS is a great way to maximize your savings and benefit from long-term tax savings.
- Carry Back Relief – You can elect for all or part of your EIS shares acquired in one tax year to be treated as though they had been acquired in the previous tax year. This gives you the option to offset the tax relief against income tax from the previous year. You can only do this if you have sufficient EIS allowance in the tax year to which you’re carrying back.
- Capital Gains Tax (CGT) Deferral - If you have released a taxable gain and invest that gain in an EIS-qualifying investment, you can defer the gain for as long as the capital stays invested and EIS conditions are not breached. Once your gain is realised, the capital comes back into charge and you pay CGT at the prevailing rate. Alternatively, you could invest in another EIS-eligible opportunity and continue to defer the gain.
- Tax-Free Returns - When you sell EIS shares after three years, you typically don't have to pay capital gains tax as long as you claimed full income tax relief on them and the companies still meet the criteria for EIS qualification.
- Loss Relief - EIS eligibility means you can reduce any loss you experience if the investment doesn't go to plan. For example, if you're an additional rate taxpayer, you can reduce a total loss of £1 to as little as 38.5p by offsetting it against your income tax bill, less the income tax relief received. To claim loss relief, you'll need to provide evidence of loss or nil value.
- IHT Relief - EIS-eligible investments can help to reduce your Inheritance Tax (IHT) bill. If you hold EIS shares for a minimum of two years and are still in possession of them when you pass away, they can qualify for 100% IHT relief. This allows you to pass on wealth to your loved ones and make sure the maximum amount of your estate goes to them free of IHT. Find out more about EIS and IHT Relief here.
Potential Tax-Free Returns
Small and medium businesses are an essential part of the UK economy, providing employment for millions of people and generating trillions of pounds in annual sales. High-growth smaller private companies are a key driver of innovation and economic growth.
While some of these high growth early stage companies may be successful, many others may find it challenging to achieve their ambitions and may fail. Investing in early-stage private companies is a higher risk and higher return investment strategy, but can be rewarding if done properly.
Overall investment performance will depend on a number of factors, and you can find more here on key areas to consider when deciding to invest in early-stage companies.
Typically, EIS funds target between 2x money and 4x money, whereas single-deal direct investments will often target returns in excess of 10x money. As with all investments, returns are not guaranteed and your capital is at risk. The key difference with EIS-qualifying investments is that, should your investment fail, you have the benefit of minimising the downside risk with the ability to claim Loss Relief as outlined in item 5 above.
Should an investment achieve a successful exit, returns are free from capital gains tax. See the example below;
- Initial Investment = £10,000
- Income Tax Relief = £3,000 (30%)
- Effective Investment = £7,000 (after 30% Income Tax Relief)
- Investment Return = £100,000 (10x Initial Investment)
- Overall Investment profit = £93,000 (Tax-Free), calculated as follows:
£100,000 (Total Capital Returned) - £10,000 (Initial Investment) + £3,000 (Income Tax Relief on Initial Investment).
If you're considering investing in early-stage companies via the EIS scheme, then it's essential to understand that some of these companies may do exceptionally well, others may just deliver average performance and others will fail. As with all investments, it's essential to spread your risk across a number of companies.
Adding alternative investments such as venture capital style EIS investments to an already well-balanced investment portfolio can provide a greater degree of portfolio diversification for experienced investors.
Portfolio diversification is essential for many investment strategies, and adding alternative investment opportunities - such as those offered by the EIS - can be a useful way to expand an existing portfolio.
EIS-qualifying investments offer you the opportunity to diversify your portfolio into investments that are largely uncorrelated to the fluctuations of listed stocks and shares. By including EIS investments in an already balanced portfolio, you can increase the diversity of your investments, reducing exposure to stock market volatility. EIS investments can be a worthwhile addition to your portfolio and complement more traditional investment strategies.
Investing in early-stage high-growth companies - the innovators and the value creators - has the potential to deliver more than just financial returns
The positive impact of investing in early-stage knowledge-intensive companies (KICs) is far-reaching and has the potential to benefit both investors and society. In addition to the potential for financial returns, EIS investments can create jobs, stimulate economic growth, and help to develop innovative products and services.
Furthermore, as early-stage startups can often struggle to obtain growth capital, EIS-qualifying investments can provide much-needed funding to enable them to launch and scale. With the right support, this can create a virtuous circle, with investors benefiting from the long-term success of the companies they invest in while also helping to create a thriving economy.
We’ve made every effort to ensure the accuracy of the material on our website, but cannot guarantee its accuracy or currency. It reflects our understanding of current product and tax rules, which may change in the future. It is general information only and should not be regarded as an offer to buy or sell any securities, or as investment or tax advice. If you are in any doubt as to the suitability of the products for your circumstances, please seek specialist financial or tax advice.