Let’s Break This Down Together…
Thinking about investing in the Enterprise Investment Scheme (EIS) but not sure what it really means or how it affects your taxes?
EIS investments can offer some of the UK’s most attractive tax reliefs, but understanding how they work and the risks involved can feel overwhelming.
Don’t worry! This guide will walk you through what EIS investments are, how the tax benefits apply, and what to watch out for, step by step. Let’s get started!
How EIS Investments Work with Your Tax
EIS investments offer one of the UK’s most generous tax incentives. They’re designed for investors willing to back early-stage, higher-risk businesses.
The Enterprise Investment Scheme encourages investment in smaller companies by providing multiple tax advantages, collectively known as EIS relief. These can significantly reduce your overall tax burden.
These investments can lower your income tax bills, defer capital gains, and potentially provide tax-free growth.
The tax treatment of EIS investments can vary depending on individual circumstances, so investors should consider their own situation when evaluating potential benefits. For many investors, they’re a valuable addition to a diversified portfolio.
What Are EIS Investments?
The Enterprise Investment Scheme (EIS) is a government initiative launched in 1994. It helps smaller, higher-risk companies raise finance by offering tax reliefs to individual investors.
EIS isn’t a fund itself but rather a tax framework. It allows qualifying companies to raise up to £5 million annually and a maximum of £12 million in their lifetime.
When you invest in EIS-qualifying shares, you’re buying shares in an EIS qualifying company. An EIS qualifying company is an early-stage, unquoted business that meets specific requirements set by HMRC to be eligible for EIS tax reliefs.
EIS qualifying companies must satisfy certain criteria, such as how the invested funds are used and the nature of their business activities. A company qualifies for EIS only if it meets these requirements.
Companies can apply for advance assurance from HMRC to confirm their eligibility for EIS before issuing shares.
Key Tax Benefits of EIS Investments
The headline benefit is 30% income tax relief on investments up to £1 million per tax year. For every £10,000 you invest, you could receive £3,000 back as income tax relief.
Investors can also claim EIS relief by following the process to claim tax relief, which involves meeting specific conditions, obtaining an EIS3 certificate, and submitting a claim within the required timeframe.
Capital Gains Tax (CGT) deferral relief is another significant advantage. You can defer paying CGT by reinvesting a capital gain into EIS shares, this is also known as deferral relief. By doing so, investors can postpone their capital gains tax liability as long as the investment remains in EIS-qualifying shares.
Any growth in your EIS shares is completely tax-free if you hold them for at least three years. This means you may benefit from a CGT exemption on any capital gain realized, substantially enhancing your overall returns compared to standard investments.
If your EIS investments perform poorly, loss relief allows you to offset losses against income tax or capital gains. The ability to claim tax reliefs depends on meeting certain qualifying conditions.
After holding EIS shares for two years, they become exempt from Inheritance Tax. This makes them a useful estate planning tool for many investors.
The availability and value of tax reliefs depend on both your individual circumstances and the company's compliance with EIS rules.
Who Can Invest in EIS and Qualifying Criteria
EIS investments are open to UK taxpayers who are qualifying investors with sufficient income tax liability. Only qualifying investors are eligible to benefit from EIS tax reliefs, and this liability needs to be enough to offset against the relief you’re claiming.
To qualify for the scheme, investors must meet certain criteria, such as not being connected to the company as a partner, paid director, or employee. This ensures the scheme benefits genuine third-party investors.
To retain the tax benefits, you must hold the shares for at least three years. Selling earlier means you’ll have to repay any income tax relief received.
The maximum personal investment is £1 million per tax year. This increases to £2 million if you’re investing in knowledge-intensive companies focused on research and development.
The timing of the initial investment is also relevant for eligibility, particularly in relation to the company's first commercial sale, as investments made within seven years of that sale are considered for EIS purposes.
Qualifying Companies for EIS Investment
Not all companies qualify for EIS. They must be unquoted and not trading on a recognised stock exchange, though AIM-listed companies can qualify.
The company’s gross assets must not exceed £15 million before any received investment. It must also have fewer than 250 full-time employees, or 500 for knowledge-intensive companies.
A company's previous investment and the timing of its initial investment are relevant for EIS eligibility. Companies must be within seven years of their first commercial sale to qualify. This ensures the scheme targets genuinely early-stage businesses.
The money raised through EIS and other venture capital schemes must come from the following sources and be used for qualifying business activities.
They cannot raise more than £5 million in any 12-month period through EIS and other venture capital schemes. Qualifying subsidiaries must be at least 90% owned by the parent company to meet EIS requirements. This maintains the focus on smaller fundraising rounds.
The scheme is designed to support smaller businesses and startups, which are key drivers of economic growth in the UK.
Understanding the EIS Compliance Statement
The EIS compliance statement is a crucial step in the Enterprise Investment Scheme process, both for companies and investors. Before any tax reliefs can be claimed, the company must submit a compliance statement, known as form EIS1, to HMRC.
This document confirms that the company and its activities meet all the requirements of the scheme, including details about its qualifying trade, gross assets, and the nature of its qualifying business activity.
The compliance statement must be submitted within two years of the end of the tax year in which the EIS shares were issued, or within two years of the date the qualifying business activity began, whichever is later.
It’s the responsibility of the company’s directors or authorised officers to ensure the information provided is accurate and complete.
The statement also requires the company to demonstrate that the investment meets the risk to capital condition, showing that investors’ capital is genuinely at risk and not protected by guarantees or preferential rights.
Once HMRC approves the compliance statement, the company receives a unique investment reference number. Investors need this number to claim their EIS tax reliefs, making the compliance statement a vital part of the process.
For both companies and investors, ensuring the compliance statement is properly completed helps avoid delays and ensures that the valuable tax benefits of the EIS can be accessed without issue.
EIS Funds vs Direct EIS Investments
An EIS fund pools investors’ money to invest across multiple companies. This offers diversification that can help manage the high risks of early-stage investing.
With an EIS fund, professional managers handle company selection, due diligence, and ongoing portfolio management. They also manage the paperwork for claiming tax relief on behalf of each investor.
Direct investments give an investor more control over exactly which companies they back. However, investors are responsible for conducting their own due diligence and managing compliance requirements.
I once invested directly in an EIS-qualifying coffee roastery. While the paperwork was substantial, the satisfaction of supporting a local business and receiving tax relief made it worthwhile.
An investor can choose to invest through an EIS fund or make direct investments in qualifying companies. Some EIS funds are “approved” by HMRC, offering accelerated tax relief.
This allows investors to claim benefits in the tax year the fund closes, rather than when investments are made.
Risks and Considerations
EIS investments are high-risk by nature. Early-stage businesses have high failure rates, and you could lose your entire investment.
These investments are highly illiquid – there’s no ready market for selling your shares, as EIS shares are typically not listed on the London Stock Exchange. This means you might be locked in for longer than the minimum three years.
Your investment may be diluted if the company raises further funding rounds. EIS shares may carry limited preferential rights, but these do not provide control over company assets or voting rights. This could potentially reduce your percentage ownership and returns.
While tax benefits are attractive, they shouldn’t be the only reason for investing. The underlying business proposition must be sound for the investment to make sense.
Final Thoughts
EIS investments represent a powerful opportunity to support innovative UK companies and play a key role in promoting economic growth by encouraging investment in businesses with high growth potential. They also offer significant tax advantages that can enhance your overall returns.
The combination of income tax relief, CGT deferral, and tax-free growth creates a compelling package.
Related government initiatives, such as the Seed Enterprise Investment Scheme and Social Investment Tax Relief, also provide tax benefits to investors and support different types of enterprises. However, these benefits come with genuine risks that shouldn’t be overlooked.
Always seek professional financial advice before making EIS investments. This ensures they align with your overall financial strategy and risk tolerance.
Pie tax: Simplifying EIS Investment Tax
Looking to make the most of EIS investments while keeping your tax affairs in order? Pie tax makes tracking and optimising your EIS tax benefits straightforward.
Our real-time tax dashboard gives you instant visibility of how your EIS investments affect your overall tax position. See immediately how much income tax relief you're entitled to.
For investors with multiple income streams alongside EIS investments, our platform brings everything together in one place. We integrate employment income, dividends, and your investment portfolio.
When it's time to claim your EIS tax relief, Pie tax streamlines the process with direct HMRC filing capabilities. This ensures you never miss out on the benefits you're entitled to.
Explore the Pie tax app if you'd like to see how it works.
Your Step-by-Step Guide
Follow these easy steps to ensure your tax reliefs are accurately recorded for your self-assessment:
Open the Pie Tax App and find the 'Quick Add' button in the middle of the navigation bar.Click 'Quick Add' in the Navigation Bar
After clicking 'Quick Add', select 'Add tax relief' from the screen to open the options menu.Select 'Add tax relief'
