Budget Explained: Enterprise Investment Scheme (EIS) – The Tax Reliefs Condensed

A look at the generous tax reliefs available under the EIS scheme, by ACCA’s budget team

EIS is one of the important and loved investment incentives. The tax reliefs are highlighted below while the business rules can be found in Enterprise Investment Scheme (EIS) –The Rules Condensed.

The Chancellor, George Osborne, has identified the Enterprise Investment Scheme as being an important scheme for encouraging investment in small business.  The scheme has been with us since 1994, having taken over from the business expansion scheme but, given the current landscape with regard to obtaining business finance, the government are keen to promote the scheme as an alternative means of promoting business finance.

The Office of Tax Simplification recently identified the EIS scheme as being “four reliefs in one”, so let us remind ourselves what these reliefs are and what changed in the Budget:

1. Income Tax Relief

From 6 April 2012, the investor may invest up to £1,000,000 (combined maximum for Enterprise Investment Scheme and Venture Capital Trust investment) in a tax year and obtain a tax reducer of 30% of the amount of investment.  It is possible to carry back the amount paid to the previous tax year.  Any amount may be carried back, subject to the overriding maximum for the previous year not being exceeded. Dividends received are not subject to income tax.

2. Capital Gains Tax Exemption

If the investor has received Income Tax relief (which has not subsequently been withdrawn) on the cost of the shares, and the shares are disposed of after they have been held for at least three years from the date of issue of the shares (or three years from the date of commencement of the qualifying trade, if later), then any capital gain on the disposal of the EIS shares will be exempt from capital gains tax.

3. Capital Gains Tax Deferral

Capital gains realised on the sale of any asset may be deferred against investments in an EIS scheme; the gains crystallise when the EIS investment is disposed of.

 4. Loss Relief

If the shares are disposed of at a loss, you can elect that the amount of the loss, less any Income Tax relief given, can be set against income of the year in which they were disposed of, or any income of the previous year, instead of being set off against any capital gains.

 

Let us look at some of these reliefs more closely by way of an example:

Mr Yorke has taxable income, after allowances, for 2012/13 of £200,000.  He makes an EIS investment on 1 November 2012 of £100,000.  Mr Yorke had previously made a capital gain on 14 October 2011 on a sculpture (after his annual capital gains tax exemption) of £100,000.

Mr Yorke has been told that he could significantly reduce his tax liabilities if he makes an investment under the enterprise investment scheme and is considering an investment of £100,000.

Let us compare his tax position firstly on the assumption that he makes no EIS investment with the position if he makes the £100,000 EIS investment:

Without EIS investment:			With £100,000 EIS Investment:
2011/12 Capital Gains Tax Position:			2011/12 Capital Gains Tax Position:
		£			£
Gain after annual exemption		100,000	Gain after annual exemption		100,000
			Less: Gain rolled over against
			cost of EIS investment		-100,000
Gain chargeable to CGT		100,000			0
CGT thereon @28%			CGT thereon @28%
(Mr Yorke has fully utilised his			(Mr Yorke has fully utilised his
basic rate tax band against			basic rate tax band against
his income)		£28,000	his income)		£0
2012/13 Income Tax Position:			2012/13 Income Tax Position:
Taxable income		200,000	Taxable income		200,000
Income tax thereon:			Income tax thereon:
34,370 x 20% =		6,874	34,370 x 20% =		6,874
115,630 x 40% =		46,252	115,000 x 40% =		46,252
50,000 x 50% =		25,000	50,000 x 50% =		25,000
		78,126			78,126
			Less:
			Tax reducer (EIS investment):
			£100,000 x 30% =		-30,000
Income tax liability		£78,126	Income tax liability		£48,126
TOTAL OF 2011/12 CGT AND 2012/13 INCOME TAX LIABILITIES		£106,126			£48,126
Tax saving:					£58,000

In the above scenario, Mr Yorke has achieved a tax saving equal to 58% of the cost of the investment or, to put it another way, he has made a £100,000 investment at a cost of £42,000.

If the shares are held for the requisite three year period, any eventual capital gain on the sale of the EIS shares themselves will be free from capital gains tax.  It is important to note, however that the gain held over from 2011/12 is only “deferred” against the EIS shares and is not itself exempt.  It may be possible for Mr Yorke to sell the EIS shares piecemeal at a later date and realise the deferred 2011/12 in stages by making part disposals of the EIS holding, thereby utilising several years’ annual CGT exemptions in the process.

If we continue the above example further:

Let us assume that that in 2015/16, the EIS investment goes bad and the company is wound-up with Mr Yorke receiving nothing for his shares.   Mr Yorke’s taxable income, after any allowances but before share loss relief, is £300,000 and he has made no other capital gains or losses during the year. Let us compare the tax position both with and without a claim for relief for the losses on the shares against income. (assume all rates and allowances remain the same as for 2011/12).

2015/16 Income Tax Position			2015/16 Income Tax Position:
assuming NO share loss relief claimed:			assuming EIS share loss relief claimed:
		£			£
Taxable income		300,000	Taxable income		300,000
			Less: Share loss relief:
			Loss on EIS shares
				100,000
			Income tax relief
			given 2011/12	-30,000
					-70,000
Chargeable to tax		300,000	Chargeable to tax		230,000
Income tax thereon:			Income tax thereon:
32,245 x 20% =		6,449	32,245 x 20% =		6,449
117,755 x 40% =		47,102	117,755 x 40% =		47,102
150,000 x 45% =		67,500	80,000 x 45% =		36,000
		121,051			93,551
Income tax liability		£121,051	Income tax liability		£89,551
Tax saving 2015/16					£31,500
Plus: Tax Savings from 2010/11 and 2011/12					£58,000
TOTAL TAX SAVINGS					£89,500

Note:  In the above scenario, the capital gain deferred from 2010/11 would crystallise but Mr Yorke could “serial” defer the gain into a further EIS investment.

It can therefore be seen that, even though the worst case scenario has happened in the above example and the investment has become valueless, the tax savings achieved can be as high as 89.5% of the original cost of the investment.  So, even though the enterprise investment is aimed at encouraging investment in smaller, higher risk companies, the tax reliefs available can make them look considerably less “risky” in the eyes of a potential investor.

 

Withdrawal of Relief

One of the biggest problems with EIS is that the tax reliefs will be withdrawn if, during the three year qualifying period, either:

• the investor or an associate becomes connected with the company
• the company loses its qualifying status
• any of the shares are disposed of (unless the disposal is to a spouse or civil partner - in those circumstances the shares are treated as if the spouse or civil partner had subscribed for them)
• the investor (or an associate) 'receive value' from the company (or a person connected with that company). Receiving value is broadly defined and includes receiving a loan or benefit from the company, or receiving an asset from the company at below market value..

There is an obligation to inform your HMRC within 60 days of any of the events above occurring.

Remember, you can see ACCA’s budget blog from yesterday, here