EIS Tax Relief

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Since its inception back in 1994, the Enterprise Investment Scheme (EIS) has been used to raise over £24 billion across more than 30,000 small businesses. 

Investing in small companies entails risks and uncertainties. While some of these companies may perform exceptionally well, others may struggle or even fail.

The tax incentives offered by the government serve as a valuable buffer against the risks associated with Enterprise Investment Scheme (EIS) investments. These incentives help mitigate the impact of underperforming investments and magnify the benefits of successful ones.

However, please keep in mind that tax regulations can change, and the specific benefits of EIS tax relief depend on individual circumstances.

Here is an overview of the key aspects of EIS tax relief:

Income tax relief:

- You can claim income tax relief of up to 30% on your investment.

- For example, a £100,000 investment could potentially result in a saving of £30,000 on your income tax bill.

- To qualify for this relief, you must have adequate income tax liability and hold the shares for a minimum of three years.

Generous contribution allowance:

You can invest up to £1 million per tax year in EIS, or up to £2 million if the amount above £1 million is invested in knowledge-intensive companies.

Carry back:

If you have sufficient allowance, you have the option to "carry back" the tax relief, offsetting it against the previous year's tax bill. This may allow you to reclaim taxes already paid.

Tax-free growth:

When you realise EIS shares, you typically do not incur capital gains tax (CGT), provided you have claimed income tax relief on the shares and the companies still qualify for EIS.

Capital Gains deferral:

By investing your taxable gains in an EIS-qualifying investment, you can defer the capital gain for as long as the funds remain invested and the EIS conditions are met.

You can defer gains of any size made up to three years before or one year after the EIS investment. Even if you have already paid the tax, you can still defer the gain.

Once you withdraw your investment, the gain becomes taxable again, at the prevailing CGT rate. Alternatively, you can reinvest in another EIS to continue deferring the gain.

Inheritance tax relief:

An investment in an EIS-qualifying company may be eligible for 100% relief from inheritance tax, provided it is held for a minimum of two years until the time of death.

Loss relief:

In case of adverse outcomes, you can choose to offset any losses against your income tax bill, after deducting the income tax relief already received. For instance, an additional-rate taxpayer could potentially reduce a total loss of £1 to 38.5p. Please see more on loss relief below.

How EIS tax relief reduces losses and magnifies gains:

When considering an investment of £100,000 in an EIS, it's important to note that the income tax relief of up to 30% can significantly reduce the effective net cost to as little as £70,000. The following table provides examples to illustrate how this, along with loss relief, can impact your returns, whether the investment performs well or poorly.

Loss relief allows you to offset any losses against your income tax. For instance, if your investment becomes worthless, you could potentially deduct the £70,000 loss from your taxable income. This offers a potential tax saving of £31,500, resulting in a maximum effective loss of only £38,500 (effective cost of £70,000 minus loss relief of £31,500). Conversely, if your investment grows by 50% due to tax relief, you could potentially achieve an effective gain of 80%.

The Enterprise Investment Scheme (EIS) is a government initiative to foster the growth of young and innovative private companies, recognizing their contribution to the UK economy. To incentivize investment in these companies and acknowledge the associated risks, the government offers a range of tax reliefs, both at the time of investment and upon realisation.

Click here for more information on EIS Investing.

It is important to note that returns from investing in these young companies can vary. Some investments may yield positive and potentially significant returns, which are often tax-free. Conversely, some investments may experience a decline in value or even fail entirely. In order to mitigate the impact of potential losses, EIS investors can benefit from loss relief. This allows for the claiming of potential losses incurred from investments in individual companies, even if the overall EIS portfolio has generated a positive return.

In this overview, we will provide a brief explanation of EIS loss relief, including the basic principles of its calculation and how to make a claim. However, please be aware that this overview does not constitute personal recommendations or tax advice. If you have any questions or uncertainties, it is advisable to seek professional tax guidance. Additionally, it is important to keep in mind that tax regulations are subject to change, and the availability of benefits depends on individual circumstances.

What is loss relief?

Loss relief provides investors with the opportunity to offset any losses incurred from an EIS company against their income tax or capital gains tax liabilities.

To be eligible for loss relief, the realised value of the investment must have fallen below the "effective cost," which is the amount invested minus the income tax relief claimed. For instance, if £100,000 was invested with an income tax relief of 30% (equivalent to £30,000), the effective cost for the investment would be £70,000.

To claim loss relief, it is necessary to have sufficient tax liabilities to offset the loss against, and the relief must be claimed within specific time limits.

Claiming loss relief against income tax involves offsetting the loss against the investor's current or previous tax year income tax bill. The amount of relief available is determined by multiplying the value of the allowable loss by the investor's marginal rate of income tax. For example, if the effective cost was £10,000 and the investment is eventually sold for £2,000, resulting in an allowable loss of £8,000, the potential loss relief against income tax at a marginal rate of 45% would be £3,600 (£8,000 x 45% = £3,600).

Alternatively, investors can opt to offset the loss against their capital gains tax liabilities for the current or future tax year. The relief is calculated by multiplying the allowable loss by the rate at which the investor pays capital gains tax. For instance, if there is an effective loss of £8,000 and the capital gains tax rate is 20%, the potential loss relief against capital gains tax would be £1,600 (£8,000 x 20% = £1,600).

Regarding deferred capital gains, if an investor had previously deferred a capital gain when investing in EIS, the gain becomes chargeable at the prevailing rate upon the disposal of the EIS shares or the liquidation of the company. Essentially, the original gain is treated as a new capital gain and must be reported on the tax return. The investor can utilise the annual capital gains tax exempt amount against the gain, or they can choose to offset the loss from the EIS investment against the deferred gain.

What happens to my shares when I die?

EIS shares are treated like any other shares you buy in the stock market. This means when you die they form part of your estate and can be passed on to whomever you choose. There is one important difference though: EIS shares could be IHT free. 

Should the death occur within three years from the investment, there is no clawback of any of the tax reliefs. IHT relief, however, could only be available if the shares have been held for at least two years.

Any beneficiary who receives the shares will not benefit from any EIS tax reliefs, so capital gains tax might be due on any gain compared with the value at the date of death of the deceased.