Enterprise Investment Schemes (EISs) – for young or old investors? is a pertinent question. There’s a funny juxtasposition around EISs in that most of the companies to be invested in are ‘early’ stage and yet many investors who could reap the tax relief benefits could be considered, let us not offend, ‘mid to late’ stage. Some of these misguidedly think themselves too old or that EISs are a young person’s game because of the nature of the underlying investments.
Clearly it is a sweeping generalisation to suggest that just because someone has long waved goodbye to their 60s that they can’t appreciate things new and starting. It is also somewhat negative to imply that the reason one should consider EISs at that age is because of the inheritance tax benefits.
If you have the funds to invest, the stomach to take some risk and an interest in new ideas and businesses then EISs could be for you whatever your age.
So, let’s start over and consider what the benefits and considerations are for anyone legitimately looking at EISs, why and how they should be investing and in which ones they could be investing in.
What are EISs?
Just to cover off the basics, EISs help start-ups raise finance by offering investors generous tax reliefs.
The tax benefits of investing in an EIS are:
- Income Tax relief of 30% of your investment. This can be used in the year of investment or carried back one year as long as the limit for relief is not exceeded for that year;
- Capital Gains exemption on profits earned on shares held for a minimum of three years;
- Loss relief, should the company you’ve invested in fail, equivalent to your tax bracket multiplied by your ‘at risk capital’ (the total loss on the shares once tax relief has been accounted for);
- Capital Gains deferral on gains realised on the disposal of any asset that’s reinvested in an EIS-eligible company;
- Inheritance Tax (IHT) exemption on shares held for a minimum of two years;
- Investors can claim EIS relief on up to £1m-worth of investments in qualifying companies per person per year (this cap rises to £2m if you’re investing in knowledge-intensive businesses, such as those in the life sciences sector);
- The scheme’s carry back feature means you can apply your EIS-eligible investments to the preceding tax year. This means that you can make a subscription of £3m EIS shares in 2017/18 with a carry back of £1m to 2016/17 so long as your EIS cap for 2016/17 is not exceeded.
Who should invest in EISs?
The question one should perhaps ask is not so much “Am I too old to invest in an EIS?” as “Am I rich enough?” Again, it is not only older investors who have wealth, younger people do but as a rule disposable income or savings to invest in something like an EIS tend to belong to older individuals.
Jason Hollands, managing director, business development and communications at Tilney Investment Management Services says his company sees very few younger EIS investors and that most EIS investors are older.
“EISs should only be considered by wealthy investors with significant assets, who are already fully maximising core allowances such as ISAs and pensions,” says Hollands. “For most of these, venture capital trusts (VCTs) would then take priority over EIS, as they carry the same income tax credits and offer tax free returns, but as diversified funds are less risky and much more liquid (VCT shares are listed). The annual VCT allowance is £200k.
Why should anyone invest in EISs?
Ironically – notwithstanding the ‘early’ nature of most companies seeking EIS funding the benefits to the investor are not particularly geared towards the ‘early’ ie younger investor.
“EISs suit investors with two particular financial planning needs: estate planning to reduce an IHT liability, or deferral of a capital gains tax liability,” says Hollands. “In both cases this typically means an older investor.”
Hollands explains that the primary use for an EIS is to reduce the exposure of an estate to IHT as EISs, unlike VCTs, are eligible for Business Relief, once the shares are held for two years and providing the EIS remains qualifying at the time of probate.
“This means assets shifted into EISs are not included in the investors estate for IHT assessment purposes, so a core use of an EIS is to help older investors with significant assets above the nil rate band for inheritance tax reduces a liability. The two-year time frame for Business Relief is, of course, much shorter than the seven-year timeline for potentially exempt transfers, another tool for passing wealth efficiently across the generations,” says Hollands.
The uncertainty of return cannot be overemphasised or over warned against when it comes to EIS investments. As Andrew Robins, tax partner at accountants RSM says, EIS investments have always been seen as high risk.
“This is partly because many EIS companies are at an early stage in their life, so the risk of failure is high, and partly because shares in them tend to be illiquid, requiring investors to lock funds in for at least three years, and sometimes for longer,” says Robins. “The tax advantages of EIS investments recognise these risks, and for the right investor can make EIS a very attractive proposition.”
Given the risky nature of the underlying investment an additional reassurance of sorts offered by the tax reliefs is that they cover both success and failure of the company, as Robins explains: “As well as an initial 30% income tax credit on investment, capital gains on other investments can be deferred by matching to the cost of the shares. These two reliefs can effectively reduce the cash cost of investing by 50%.
“If the EIS company fails, the loss suffered on the company failure can be set against income or capital gains, so in an extreme case an investor can claim tax relief of over 60% of the amount invested.” (see box for an example of how the relief works).
“On the upside,” Robins continues, “Provided you hold your EIS shares for at least three years, and the company meets qualifying conditions, any profit made on disposal is tax free (although any deferred capital gains will become payable at this point). In addition, EIS shares held for at least two years are currently free from inheritance tax on the death of the investor.”
Further reading: Bloodstock investing EIS offers a way to bet on the horses
Where could you invest in EISs?
Some EIS investments Calculus Capital, the EIS and VCT fund manager highlight are:
Weedingtech – not exactly one for the gardeners out there (yet?) but the company is leading in herbicide-free, non-toxic weed control, used in municipal and agricultural markets offering an alternative to herbicide which are associated with health issues.
Oxford BioTherapeutics – the company has a strong pipeline of immune-oncology therapies, which are used to re-engage and recruit the body’s immune system to attack cancer cells, providing targeted treatment strategies to patients most in need.
Mologic – a developer of cutting-edge Point of Care (PoC) diagnostic devices, designed to improve the lives of patients by giving them the opportunity to manage their own condition in the home environment.
Loss relief example
Ms A invests £100,000 in EIS shares. She claims the full 30% tax credit against her tax liability of the year. Two years later, the company fails. At this point Ms A realises a capital loss on her investment. The loss is calculated as the initial purchase price less tax relief and any proceeds received. If Ms A receives nothing from the company, her capital loss will be £100,000 – £30,000 = £70,000. Normally, a capital loss can only be set against capital gains of the same or later years. However, losses on unquoted trading companies can also be set against income in most cases. If Ms A is a 45% taxpayer, she will be able to claim tax relief of £70,000 x 45% = £31,500, to add to the £30,000 relief received up front.
Any capital gain deferred against Ms A’s investment will be triggered when the company fails, crystallising the 20% CGT liability due on the original gain that was held over.
The EIS benefits that attract distinct types of investor:
- The 30% tax credit plus potential investment upside are attractive to high earners, who have spare cash to invest and plenty of income to offset.
- The combination of income tax and CGT reliefs is attractive to mature investors who have surplus funds available to invest and are generating gains.
- The IHT exemption is attractive to older investors looking to reduce the amount of tax payable on death.
Robins says he sees EIS investors in all three of these groups. The first two groups tend to be more interested in potential investment growth, and the third group in minimising risk of loss, which can have an effect on investment choices, but in many cases the investor will buy shares in a range of companies to mitigate risk.
For many more on EISs see the special report in What Investment magazine October issue out at the end of the month at certain retailers or subscribe.