Question : Can you please explain the tax benefits of investing into an Enterprise Investment Scheme?
Answer: The question you ask is becoming more frequent these days and given the tax rises recently announced in the Budget, the growth in the Enterprise Investment Schemes (EIS) market is likely to continue.
As with any tax planning however it is important to understand exactly the benefits and likely pitfalls of putting money into such arrangements.
EIS were introduced some time ago, in order to encourage investors to place money with small companies.
The rules as to which companies can qualify are very complex but in essence the company to which the money is to be invested should be conducting a qualifying trade.
Qualifying trades encompass all forms of business activity except those which involve financial activities, the buying and selling of property and legal or accountancy services.
Because these types of companies are by their very nature higher risk in terms of an investment proposition, the Government offers tax incentives to encourage investors to consider them.
The first tax incentive a potential investor qualifies for is a reduction in income tax. Any investment made into an EIS will provide a 20% tax credit against an individual’s personal tax liability.
So if an investment of £100,000 is made, then the individual will receive £20,000 tax relief, providing there is a large enough tax bill to absorb the relief.
The maximum investment that can qualify for tax relief is £500,000.
Therefore the maximum income tax an individual can save is £100,000 if they maximise the allowance.
The second tax incentive centres on capital gains tax. If an individual holds an EIS scheme for three years, then any growth on maturity will be free of any tax.
If the investment makes a loss over that period, then the individual can either claim the loss against capital or income tax.
Similarly if you have paid capital gains tax in the last three years, then you may be able to reclaim the tax you have paid and subsequently defer it via an EIS arrangement.
This may be advantageous as the deferred tax gain is payable at the rate in force when you sell the EIS investment.
So for example, an individual who sold a property two years ago, and paid tax at 40%, may now be able to reduce that tax rate to 18% simply by making an investment into an EIS.
The third tax incentive revolves around Inheritance Tax. Once an EIS investment is held for two years, then that investment falls outside of an estate for inheritance tax purposes.
This is attractive to individuals who are looking to minimise their overall estates, whilst at the same time retaining control of their investments.
Despite all the tax incentives, as I mentioned earlier, investments into EIS are ultimately made into smaller unquoted companies.
These, by their very nature, are considered to be higher risk than mainstream investments, so it is important to weigh up the investment risk against all the possible tax breaks.
The rules are also very complicated and interrelated with other legislation so it is essential that you consult a professional who is experienced in this area to ensure that if you are to invest in an EIS, you are fully aware of all the implications from a tax and investment perspective.
It is important to ensure that you don’t enter into an investment just purely on a tax basis and find out later that it ultimately does not fit into your overall plans and objectives, or indeed your risk profile.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact: firstname.lastname@example.org or telephone (028) 9022 1010