The Enterprise Investment Scheme (EIS) was created by the British government over 25 years ago to provide a number of incentives for investors to back new and smaller UK firms.
A scheme with the potential for high returns and tax relief, where your clients’ investments can also help grow industry and create jobs… Too good to be true?
Yes and no. The potential for high financial returns exists with EIS, however, as is often the case, they can also lose money. The government will provide incentives for them to invest, but will not act as a guarantor for their funds.
In this article we will explore the various tax reliefs available and the pros and cons of EIS - a guide for both financial advisers and accountants working with small business and investor clients.
Created in 1994, the Enterprise Investment Scheme (EIS) was launched in order to stimulate and facilitate investment in new UK businesses. The idea being that as new businesses grow and become more productive and profitable, jobs are created, and economic growth is more likely.
According to the Enterprise Investment Scheme Association (EISA), funding from EIS increased to £1.905 billion in 2020/2019 up from £1.867 billion in 2019/2018.
Small businesses can benefit from EIS investment, with the government providing a platform to connect them with the right investor. However, not all businesses qualify so read on to see if your clients do.
Which businesses qualify for EIS?
As the scheme is primarily for promoting the growth of new businesses, the criteria are as you might expect from such a scheme. You should also bear in mind that the government aims to direct funding towards those clients who need it the most.
Small business EIS qualifying criteria
Be trading and cannot be listed on the stock exchange (excluding AIMs)
Not be in one of the specified excluded industries including: property development; banking and insurance; legal services; farming and forestry activities; or energy production. A full list of exclusions can be found at the government website here.
Be less than seven years since their first commercial sale.
Employ fewer than 250 people.
Have less than £15 million in gross assets.
Businesses under two years old and with fewer than 25 employees may find the Seed Enterprise Investment Scheme (SEIS) more appropriate. More can be found about SEIS here.
Rules on fund expenditure
In addition to the terms above, there are also rules on how EIS funds are spent. These rules include:
EIS investors must purchase new rather than existing shares.
Funds must be used in the pursuit of growth, not on fixed or maintenance costs.
Any funds raised via EIS must be spent within two years.
Maximum annual limit on EID fundraising is £5 million. The total amount that can be raised over the lifetime of the business from EIS is £12 million.
The government wants new businesses to succeed, and the EIS provides the funding platform that allows your clients to get involved, with tax incentives aplenty.
How do clients invest in EIS?
There are two routes to investing funds in EIS.
Direct investment
This is exactly as it sounds; investors can do their own research, draw up a shortlist and locate their investment target themselves.
Financial adviser, accountant or specialist EIS manager
Using a financial adviser, accountant or specialist manager means that clients benefit from your knowledge and expertise around EIS. The right adviser will have a general oversight of companies, and some may even sit on company boards, bringing influence to the table. As a skilled expert, you will be well placed to guide clients through the exit process and the timing of fund withdrawal.
Income tax
Investors are permitted to claim 30% income tax relief on EIS investments which may offer a counterweight to the high risk involved in backing a new company.
With the maximum EIS investment being £1 million, the most they can expect to receive back from HMRC is £300,000.
Capital gains tax
If investors hold their shares for over three years and claim income tax relief, then any gains made on investments will be free of capital gains tax. This is a particularly attractive proposition given the fast growth seen by many early-stage businesses.
They may also become eligible for deferred capital gains tax on capital assets. This means that any gains they make on investment will have their taxes deferred on these gains.
Business property relief
Inheritance tax relief on EIS gains can be achieved through application of business property relief. That is, EIS shares can be left to beneficiaries, as long as they have been held for at least two years at the time of death.
Loss relief
Even if your client owns a portfolio of EIS investments, loss relief is still available on those companies that provide a loss – even if their overall portfolio sees a gain.
The amount of loss relief an investor can claim is calculated by multiplying the value of the loss with their marginal rate of income tax.
This continues the theme of government support for what is seen as a higher-risk investment option.
Investors could spend a long time researching EIS qualifying companies, so your expertise can help them through this.
Even if they do settle on an investment option through their own research, with so many qualifying criteria and spending rules, they’re going to need someone to help them steer their way through – and out.
If a company changes its qualifying status, then your client may not only lose tax-relief benefits, but also end up having to pay some back.
As a financial adviser or accountant, you will be well placed to help keep them ahead of the curve, ensuring no surprises on their tax return.
EIS is a long-term investment that offers clients the opportunity for both high risk and high gain. You can help minimise the risk and maximise the gain.
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