EIS Tax Relief in brief

Allen & Atherton’s brief guide to the various advantageous tax reliefs available to EIS investors.

Many high-earning individuals — most commonly those who have maxed out both their SIPP and ISA tax year contributions — turn to EIS investments in order to continue with tax-efficient investing.

Of course, investing in small unlisted companies is not for the faint-hearted. While some offer the opportunity to generate extraordinary returns, others struggle and many fail entirely. However, Enterprise Investment Scheme investors benefit from generous tax incentives designed to mitigate the impact of investments which fail and amplify the returns of those which succeed.

As a caveat, it’s worth noting that the government retains the power to change tax rules, even retrospectively.

Investing in EIS-qualifying companies boasts multiple advantageous tax reliefs, including:

Income tax relief of up to 30%, where a £100,000 investment can provide up to £30,000 off the tax year’s income tax liability. You must of course have sufficient income tax liability originally and must also hold your EIS-qualifying shares for a minimum of three years.

A generous contribution allowance of up to £1 million per annum, or up to £2 million where investments over £1 million is invested in (riskier) knowledge-intensive companies (KICs).

Carry back tax planning advantages, where you can offset tax relief against the previous tax year’s bill and even get back tax already paid to HMRC.

Growth free from Capital Gains Tax liability when selling EIS-qualifying shares if you have already claimed income tax relief and the companies still qualify for the status.

Capital Gains deferral, where gains invested inside an EIS-qualifying investment sees the tax on the original gain deferred as long as the money stays invested and the company remains EIS-qualifying. Gains of any size up to the contribution allowance limit made up to three years before, or one year after the investment is made, qualify for deferral.

Once EIS shares are sold, the original gain becomes chargeable, but only at the prevailing rate, and continuing to invest the gain into another EIS-qualifying company in theory allows you to defer the gain indefinitely as it is often eliminated upon death.

Inheritance tax relief of 100% applies to EIS shares as long as they are held at the time of death, and for at least two years prior to death.

Loss relief on EIS shares mean you can offset any loss made, less the original income tax relief, against your income tax or capital gains bill. For context, in some cases an additional ratepayer can reduce their total loss in an individual EIS-qualifying company from 100% to 38.5%.

EIS tax relief example

While very simplified, a £100,000 investment into an EIS-qualifying company leaves the initial net cost at £70,000 assuming income tax relief at 30%. If the investment succeeds, then not only are the gains tax-free, the gain itself is amplified as you have exposure to £100,000 worth of shares for £70,000 of risk.

And if the investment fails — a not uncommon outcome — then the entire £70,000 loss can be set against your taxable income. This yields a further tax saving of up to £31,500 depending on your income/CGT status, leaving a total cost of £38,500 for the initial investment.

Further, loss relief applies to individual loss-making EIS companies, even inside a portfolio which has yielded a positive result overall.

What happens to my EIS shares upon death?

EIS shares are treated like listed shares upon death in that they form part of your estate and can be passed onto whomever you choose. However, EIS shares are usually not subject to inheritance tax when they have been held for at least two years, and if your death occurs within three years from the investment, there is no clawback of the various tax reliefs.

As a caveat, there are extremely complicated rules dictating the various tax reliefs assigned to spouses, children, or any other beneficiaries when receiving EIS shares from your estate. Specialist advice is strongly advised if you feel this may be a possibility, and given the complexity of the various interlinked tax reliefs, few invest into EIS shares without professional support.

We here at Allen & Atherton are ready and able to assist.