Making an early investment in shares of small businesses is one of the best ways to improve personal wealth. The earlier you invest, the more value you will receive.
However, investing, particularly in small or new businesses, is tricky.
But with EIS providing various advantages to investors, such as offering them significant tax advantages, investors can still invest in small and new businesses while expecting high growth and rewards.
EIS vs SEIS
Recognising the difficulties that new and early-stage companies experience in raising the funding they require to expand, these programs offer generous tax relief to investors ready to put their faith and money into these profitable businesses.
Here are some of the differences between EIS and SEIS for investors.
- EIS has 30% income tax relief, while SEIS has 50%%.
- Both EIS and SEIS are exempt from capital gains tax on the investment.
- With EIS, there is a straight deferral regarding 'rollover' of other gains, while with SEIS, there is a conditional exemption of 50%.
- The maximum EIS investment is £1,000,000 and £100,000 with SEIS.
You can read more about the differences between EIS and SEIS here.
Who might consider EIS
Investing is not for everyone, as returns aren't guaranteed. It's based on the performance of your investments and how much they're worth when you sell them. You must be willing to risk losing some or all of your money.
And with EIS, it's not for beginners starting to look at investment opportunities (SEIS is more suitable for beginners). Those serious about investing in EIS should ensure that they have a significant enough tax liability to qualify for the tax benefits.
EIS investments are considered high-risk, and if you're looking for more stable investment opportunities, you should look into other options.
Also, because one of the primary requirements is to keep your shares for at least three years, EIS may not be suited if you're seeking shorter-term investments.
The following are examples of typical EIS investors:
- With a large income tax bill
- With a capital gain from selling shares, a business, or investment property, and are looking to defer paying CGT
- Has received a tax-free lump payment from a pension and wishes to reinvest to obtain tax relief
- Reached the maximum level for pension contributions and the Lifetime Allowance
Also, limited companies can invest in EIS qualifying companies, but they will not be eligible for tax relief benefits. Individuals are the only ones who can benefit from tax relief.
Benefits Startup Investors Get From EIS
1. Income Tax relief
Income Tax Relief is one of the notable tax benefits provided by EIS. With this, investors can claim 30% of their initial investment. It works by reducing the investor's income tax bill, taking off an amount equivalent to 30% of the EIS eligible investment.
EIS investments must be held for three years to keep the tax benefits.
2. Capital Gains Tax
Capital Gains Tax is a tax on the profit when you sell (or 'dispose of') an item (an 'asset') that has increased in value. The gain you make is taxed, not the money you receive.
All financial gains over £6,000 are subject to CGT (except your primary residence or vehicle). Your tax band determines the amount you pay and ranges from 10% to 28%. Most investors would've spent at least 20% CGT on their gains.
Gains on residential property (not their primary residence) are taxed 18% for basic rate taxpayers, and gains on all other assets are 10%. Higher and additional rate income taxpayers have to pay CGT at 28% for residential property (other than their primary residence) and 20% on other assets.
If you use your gain from the sale of any asset to make any amount of investment in a company that's EIS qualified, you won't have to pay Capital Gains Tax immediately.
You must hold onto shares for a minimum of 3 years to be eligible to claim CGT relief on the investment.
3. Capital Gains Tax Deferral
EIS gives a second relief affecting Capital Gains Tax. This relief allows you to delay paying CGT on any asset if the gain from the disposal of that asset is used to buy shares in another EIS qualifying company.
To qualify for CGT deferral, gains from the sale of EIS shares must have been made within a year or within three years of the EIS investment, and only the amount invested qualifies for the relief.
If you apply for a gain deferral, the gain may be charged to CGT in a later tax year, usually when you dispose of your EIS shares.
You can also claim Deferral Relief if you receive Income Tax Relief on the acquisition of shares, although you don't have to obtain Income Tax Relief to claim Deferral Relief.
4. EIS Loss Relief
EIS Loss Relief lessens the impact of losses on EIS investments.
You can cover losses on an EIS company by claiming loss relief with two options: your income tax bill or your capital gains tax bill.
Depending on the tax rate you pay, the relief will be worth anywhere from 20% to 45% of your loss.
Claiming loss relief against income tax
With EIS, an investor may offset a loss against their income tax bill for the current or previous tax year. The amount of relief you can claim is done by multiplying the value of their effective loss and their marginal income tax rate.
For example, if the investment's effective cost was £20,000 and it was sold for £5,000, the effective loss is £15,000. With a marginal income tax rate of 45%, the amount of loss relief that could be claimed against income tax is £9,000.
Claiming loss relief against capital gains tax
It may be more suitable to offset your loss against your capital gains tax bill for the current or future tax years. The relief is then determined by multiplying the effective loss by the rate you pay capital gains tax.
5. Inheritance Tax relief
Inheritance tax is a tax on a deceased individual's estate (their land, assets, and possessions).
Assume that the value of your estate is less than £325,000 or that you give anything above £325,000 to your spouse, civil partner, a charity, or a volunteer amateur sports club. In this instance, there is usually no need to pay inheritance tax.
After two years of owning EIS shares, you can claim up to 100% inheritance tax relief. This is eligible only if the shares aren't listed on a recognised stock exchange.
Funds from your estate are used to pay Inheritance Tax to HMRC. If there is a will, the person in charge of the estate is responsible.
Usually, your beneficiaries (those who receive your inheritance) don't pay taxes on their inheritance. They may be subject to relevant taxes, such as getting rental income from a house left to them in a will.
However, if you give £325,000 as a gift and die within seven years, the people you gave gifts to may be subject to Inheritance Tax.
A carryback allows all or part of the cost of shares bought in one tax year to be recorded as if they were purchased in the previous tax year. The relief is then applied to the income tax liability of the prior year instead of the tax year the shares were acquired. This is determined by the overriding limit for relief for each year.
Although income tax relief can't be carried forward, it can be used to a previous year if you haven't reached the £1,000,000 limit on EIS shares for that year.
7. Business Investment Relief
Business Investment Relief (BIR) is a potentially beneficial tax relief for UK resident non-domiciled individuals who want to bring funds into the UK to invest in a qualifying trading company without paying tax on the money.
The amount that can be claimed under this relief is limitless.
However, some conditions must be met, such as:
- The investment should be in a qualifying company (the 'target company' – see below).
- The investment should be made within 45 days of the offshore income or gains being brought to the UK.
- The investment may be in shares (either preference or ordinary) or loans. From 6 April 2017, this includes acquiring existing shares rather than just newly issued shares (as was the case before 6 April 2017).
- The investor or any 'relevant person' can't obtain any benefit attributable to the investment. A spouse or civil partner, children or grandchildren under the age of 18, trustees of a settlement in which a relevant person is a beneficiary, and a participator in a close company are all examples of relevant people.
- The proceeds of sale up to the original investment amount must be taken offshore or reinvested in another eligible company within 45 days of disposal of the investment.
To be considered a target company for BIR purposes, a company must meet all of the following criteria:
- Required to be an unquoted company (including Alternative Investment Market (AIM) companies and
- Required to be a trading company or be planning to within two years of the date of the investment; and
- All, or nearly all, of the company's activities, must be related to commercial commerce. Although the term "substantially all" is not defined, HMRC guidance specifies that where the commercial trade accounts for at least 80% of a company's total activities, the company will generally be regarded as meeting this requirement.
Suppose a holding company is a member of an eligible trading group. In that case, it may also qualify.
EIS provides a safety net for investors, making you have a greater willingness to take a chance to improve personal wealth and gain high growth and rewards.
If you're interested in investing in EIS or you want to know more about the scheme, you can give us a call.
Rest assured that our team will get in touch with you and assist you in your investment journey.