In the first instalment of our Spotlight series, which takes a look at a range of investment solutions available to clients on the market today, we delved into Venture Capital Trusts (VCTs). Today, we take a closer look at its very slightly older sibling, the Enterprise Investment Scheme (EIS).
Whereas VCTs were introduced by the government in 1995, the EIS was launched a year earlier to help small UK companies raise capital from private investment. Ever since, investors have been rewarded with considerable tax incentives in return for injecting enterprise capital into unlisted or AIM listed companies.
Impact on SMEs
It’s a particularly interesting time for the EIS at the moment, with the impacts of the COVID-19 pandemic still being felt acutely by the small and medium enterprises (SMEs) who benefit from the scheme. In the 2020/21 tax year, investment in EIS-qualifying businesses stood at £1.6bn, however this was down by 12% on the previous year.
This reflects the wider challenge for SMEs nationwide, who are looking to adapt and raise investment in turbulent economic times. For SMEs looking at the EIS as a means of raising capital, they must meet set criteria and some types of businesses are excluded all together.
Suitable for a range of investors
It's a common misconception that such investments are only suitable for multi-million-pound investors. In fact, the truth is that tax-efficient investments like EIS or VCT funds are suitable for those looking to invest a smaller amount, too. However, while you still need excess funds beyond your day-to-day expenditure needs, these types of investments are typically considered after other, higher priority vehicles have been utilised. They will also be dependent on specific circumstances and attitudes towards investment risk.
Niche Ops Director, Aled Phillips, also suggests that, unlike some of the bigger funds out there, EIS funds can bring some very exciting investment opportunities. He says, "Many EIS companies invest in businesses that have a disruptive technology, and there are some great examples in life science in particular, so for certain clients, they are an excellent opportunity."
Benefits to investors
Yet, with all of that said, there are also a host of benefits and drawbacks to you as an investor. In particular, the EIS offers you generous tax incentives to private investors resident in the UK for tax purposes. It’s important to remember that in order to retain these incentives, you must remain invested in the EIS for a minimum period of three years. Should you withdraw prior to that point, you will be required to pay any tax reliefs you have received.
- An EIS comes with Income Tax relief of 30% of the investment. This can be applied to the existing tax year or to the previous tax year. Based on an investment of £100,000, you could receive relief of £30,000.
- You receive exemption from Capital Gains Tax (CGT) on the disposal of EIS shares, provided you have held them for at least three full years from investment.
- Shares in EIS-qualifying business are eligible for Business Property Relief, meaning that after two years of holding the shares, they become Inheritance Tax (IHT) exempt.
- During the life of an investment, you can benefit from CGT deferral. If you are reinvesting funds that were initially liable to CGT, this will allow you to retain this benefit.
Pitfalls to consider
As with all investment options though, there remain key considerations to bear in mind prior to making your decision:
- Your capital is at risk, and you may lose money. EISs are considered high-risk investments and the value of any investment could fall, or even be totally eliminated.
- The values of smaller, unquoted companies are highly volatile and subject to much sharper rises and falls than larger, more established businesses.
- As EIS companies are not listed on any exchanges, there is no active market to sell your shares for a return on investment. As a result, the investment is considered illiquid and you must wait until the company secures an exit, at which point the proceeds of your investment will be returned.
- Tax rules, rates and reliefs are current legislation which could be subject to change in the future.
- Although the investment period for EIS reliefs is 3 years, the investment period can be a much longer duration, depending on the performance and growth of the underlying companies.
EISs are high-risk investments and are not suitable for everyone. With that in mind, if you are also interested in finding out whether an EIS may be appropriate for you and your circumstances, then please feel free to contact your adviser directly, or call us on 01633 859555.
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The value of an investment and the income from it could decrease as well as increase. The return at the end of the investment period is not guaranteed, and you may get back less than you originally invested.
Please note that VCTs are high risk investments and there may be no market for the shares should you wish to dispose of them. Your capital may be at risk.
EISs are very high risk investments. An EIS investment is usually concentrated in one single unquoted trading company. Often there is no market for the shares and it may be difficult to make a disposal. There is a possibility of the chosen company failing.