EIS: Missed tax opportunity

Understanding the Enterprise Investment Scheme (EIS)

The Enterprise Investment Scheme (EIS) is a UK government initiative designed to encourage investments in small, high-risk companies by offering tax reliefs to individual investors. This scheme aims to stimulate economic growth by making it more attractive for investors to support early-stage businesses.

Benefits of EIS

1. Income Tax Relief: Investors can claim up to 30% income tax relief on the amount invested in EIS-qualifying companies. For example, if you invest £100,000, you can reduce your income tax bill by £30,000.
2. Capital Gains Tax (CGT) Relief: Any gains on the disposal of EIS shares are exempt from CGT, provided the shares are held for at least three years. Additionally, investors can defer CGT on gains from other assets if the proceeds are reinvested into EIS shares.
3. Loss Relief: If the investment does not perform well and results in a loss, investors can offset the loss against their income tax or CGT bill. This is calculated based on the effective cost of the shares (the amount invested minus any income tax relief received).
4. Inheritance Tax Relief: EIS shares are exempt from inheritance tax if held for at least two years, making them a valuable tool for estate planning.

Requirements for EIS

To qualify for EIS, both the investor and the company must meet specific criteria:

1. Investor Requirements:
   • The investor must not be ‘connected’ with the company, meaning they should not hold more than 30% of the company’s shares, voting rights, or rights to assets upon winding up.
   • The investor must not be an employee of the company. However, they can be a director, provided they are not remunerated. You can still get dividends.
2. Company Requirements:
   • The company must be based in the UK and carry out a qualifying trade.
   • It must have fewer than 250 full-time employees at the time of investment.
   • The company’s gross assets must not exceed £15 million before the investment and £16 million after the investment.
   • The company must not be listed on any recognized stock exchange.

Qualifying Trades

For a company to qualify for EIS, it must engage in a qualifying trade. A qualifying trade is one that is conducted on a commercial basis with the aim of making a profit. However, certain activities are excluded from being considered qualifying trades. These excluded activities include:

• Dealing in land, commodities, or futures.
• Dealing in shares, securities, or other financial instruments.
• Banking, insurance, money-lending, debt-factoring, hire-purchase financing, or other financial activities.
• Leasing or letting assets on hire.
• Legal or accounting services.
• Property development.
• Farming or market gardening.
• Operating or managing hotels or nursing homes.
• Generation of energy, such as electricity, heat, or gas.
• Production of coal or steel.
• Providing services to another business that carries out excluded activities, where the service provider is under the control of the other business.

It’s important to note that a company can still qualify for EIS if these excluded activities do not constitute a substantial part of its overall trade. Generally, HMRC considers activities to be substantial if they account for more than 20% of the company’s total activities.

Industries Allowed Under EIS

EIS supports a wide range of industries, provided they engage in qualifying trades. Some of the industries that typically qualify include:

1. Manufacturing: Producing goods from raw materials.
2. Research and Development (R&D): Engaging in innovative activities to develop new products or processes.
3. Information Technology (IT): Developing software, hardware, or IT services.
4. Engineering: Providing engineering services or developing engineering products.
5. Biotechnology: Engaging in the use of biological processes for industrial and other purposes.
6. Creative Industries: Including film production, music production, and other creative arts.
7. Retail and Wholesale: Selling goods directly to consumers or other businesses.
8. Hospitality: Operating hotels, restaurants, and other hospitality services.
9. Education: Providing educational services or products.
10. Healthcare: Offering medical services, products, or healthcare innovations.
11. Environmental and Renewable Energy: Engaging in activities related to environmental conservation or renewable energy production.

Example of EIS in Action: Pharmacy

Let’s consider an example to illustrate how EIS works with a pharmacy:

Scenario: Jane decides to invest £100,000 in a startup called HealthPlus Pharmacy Ltd, which qualifies for EIS.

1. Income Tax Relief: Jane can claim 30% of her investment as income tax relief, reducing her tax bill by £30,000.
2. Capital Gains Tax Relief: After holding the shares for three years, Jane sells them for £150,000. The £50,000 gain is exempt from CGT.
3. Loss Relief: If HealthPlus Pharmacy Ltd fails and Jane sells her shares for £50,000, she can claim loss relief on the £20,000 loss (the effective cost of £70,000 minus the sale proceeds).
4. Inheritance Tax Relief: If Jane holds the shares for at least two years, they will be exempt from inheritance tax.

Conclusion

The Enterprise Investment Scheme offers significant tax incentives to encourage investment in early-stage companies, providing benefits such as income tax relief, CGT relief, loss relief, and inheritance tax relief. By meeting the scheme’s requirements, both investors and companies can leverage these advantages to support innovation and economic growth.