EIS - FOUR RELIEFS IN ONE
When EIS relief is mentioned in conversation, it’s usually the income tax relief that is being referenced, owing to the opportunity to claim a substantial tax reduction which makes it a powerful planning tool. However, this sells the EIS short. The scheme is actually a collection of four tax reliefs badged as one.
What are the four tax breaks?
- Income tax relief
- Capital gains tax (CGT) deferral
- CGT exemption
- Loss relief
How does the income tax relief work?
The blue riband of the EIS, income tax relief, is given as a tax reduction against the overall tax liability for the year the investor subscribes for qualifying shares. Alternatively, the investor can make an election to utilise some, or all of the relief in the preceding year.
The current rate of relief is 30% on up to £1 million of qualifying investments per tax year. This maximum is doubled to £2 million if the issuing company is a “knowledge intensive company”. Whilst the relief can lead to a refund, e.g. where tax has already been paid via PAYE, it cannot create a repayment (or further repayment) by reducing the overall tax liability below £nil.
This is where the election to carry back the relief comes in useful - if the relief available exceeds the tax liability for the year of the investment, look to see if the carry back claim might help.
Arthur makes a qualifying investment of £100,000 in 2019/20. His overall tax liability for the year is £20,000, of which £18,000 has been deducted via PAYE. Arthur qualifies for £30,000 of EIS income tax relief, but this will be restricted to £20,000 because he does not have a sufficient tax liability to offset. He will receive a refund of £18,000 and will have no further tax to pay via his self-assessment return, but the additional £10,000 is effectively lost unless it can be carried back to 2018/19.
What is the CGT deferral?
CGT deferral allows an investor who makes a qualifying investment to defer the tax payable on other gains made until the EIS shares themselves are sold later on. This is done by matching the amount invested in EIS shares to gains arising in the period beginning three years before and ending one year after the EIS investment takes place.
Katie (a higher rate taxpayer) makes capital gains after the annual exemption of £250,000 in 2019/20. She pays the tax of £70,000 in January 2021. In May 2021 she makes a qualifying EIS investment of £250,000. If she chooses to, she can use the EIS investment to match the £250,000 gains from the 2019/20 tax year and defer the CGT payable. She would receive a refund of £70,000 and would only have to pay this back in the event of a later disposal (or disqualifying event).
The handy thing about CGT deferral is that it is available to investors with a connection to the company, e.g. employees.
What about CGT exemption?
The third relief is an exemption from tax on any gains made on the EIS shares themselves. If an investment in an EIS company is successful and sold at a profit, the gain would not attract CGT. In order for the CGT exemption to apply, some income tax relief must have been attributable to the shares in the first place. Case law has established that this relief must have been claimed, not merely claimable, for the exemption to apply.
And loss relief?
Usually, capital losses can only be used to offset capital gains. However, in some circumstances losses that arise on the disposal, or deemed disposal, of certain shares qualify for something called share loss relief and can be deducted from general income instead.
Where a loss arises on EIS shares that attracted income tax relief that has not been withdrawn, the loss will automatically meet the conditions for share loss relief. The loss is restricted by any income tax relief that has not been withdrawn.
What is the overall effect of these reliefs?
In cash terms, utilising the reliefs in full has a significant effect on the downside risk of making an investment. If you consider how you might feel about making an investment of £100,000; in the absence of EIS your risk is going to be £100,000, i.e. the absolute worst that can happen is that you lose £100,000 in cash.
If you make the investment through the EIS, the risk is significantly reduced. Let’s assume that you are an additional rate taxpayer who would be fully able to utilise any share loss relief on a failing investment. Your investment would attract £30,000 of income tax relief initially. If the underlying company then failed completely, you would have £70,000 (£100,000 - £30,000) to use as a loss relieved against your income. Assuming you are still an additional rate taxpayer this would be worth £31,500 as a further relief. This means the real cash risk of your investment is only £38,500.
These reliefs do not come without a word of warning. An investment in an EIS company carries an inherently high risk when compared to making an investment in a public limited company quoted on the stock exchange. But this is exactly the point. Nonetheless, you should always take advice from a reputable financial advisor before undertaking to commit any money.
- Income tax relief is given at an effective rate of up to 30% of the amount invested.
- Relief can be carried back if it can’t be utilised in full in the year of investment.
- There are three capital gains tax reliefs: deferral relief, disposal relief and loss relief.
- Used together, the reliefs significantly reduce the cash risk of making the investment.