EIS – A Legal & Ethical Tax Haven
23 May 2014
An investment in an Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) is not for the fainthearted. Shares which fit the criteria for either of these schemes are high risk investments. As you might expect, however, the potential returns match this high risk, particularly when you take into account the enormous tax benefits you can obtain.
Steve Govey explains:
Regardless of your tax rate you will receive an Income Tax reduction of 30% of your investment in an EIS company or 50% of your investment in a SEIS company, subject to a maximum of your tax liability.
You can defer any taxable capital gains completely if the proceeds are invested in EIS shares. This means you can defer paying 18% or 28% Capital Gains Tax, depending on your tax rate. Under SEIS, half of the capital gain can be fully exempted from Capital Gains Tax by investing in SEIS.
Any gain in your investment is tax free, as long as you hold onto your investment for at least three years. If you make a loss on EIS or SEIS investments you can set this off against your Income Tax liability.
After two years your investment will be free of Inheritance Tax - a further tax saving of 40% if you own more than the Nil Rate Band of £325,000. If you still hold the investment when you die, any deferred capital gain will die with you.
Loss Relief Provision
This ability to claim “sideways relief” against your Income Tax liability, whilst at the same time not having to pay any Capital Gains Tax on growth, is an enormous benefit.
Imagine you are a 45% tax payer who invested £1,000,000 in equal tranches in ten different companies five years ago. Half of them have now gone bust and half have doubled in value. We will assume you invested in an EIS portfolio, but the principle will be the same whether you invest in EIS companies or take advantage of the greater tax break in SEIS companies, albeit subject to a maximum investment of £100,000 for SEIS. You will only really have invested £700,000, as you will have obtained a £300,000 tax credit.
As half of your investment is lost you can claim relief against your income for a loss of £500,000 less the £150,000 EIS income tax relief previously claimed i.e. loss relief on £350,000, resulting in a tax benefit of £157,500 against this year’s Income Tax bill as a 45% taxpayer.
The other companies now double in value and you decide to realize your investment in them. This gives you £1,000,000 (double the £500,000 you originally invested).
In summary, you have invested £542,500 net (£1,000,000, less £300,000 tax credit, less £157,500 loss relief) and received £1,000,000 back – an overall return of £457,500, or almost 85%. Not a bad return in five years, considering the average growth in your portfolio was zero!
Passing on to the Next Generation
Imagine your main concern is passing on to your grandchildren a £420,000 gain you have made on a property portfolio. As you have made other gains in the year as well and are already a 45% tax payer, the £420,000 gain is subject to 28% Capital Gains Tax, leaving you £302,400.
You hold on to that £302,400, which neither grows nor falls in value, until you die. Let’s assume you have other assets taking up the Nil Rate Band. Your grandchildren will therefore have a £120,960 Inheritance Tax bill, leaving them just £181,440 of your original £420,000 gain.
Alternatively, you could choose to invest £600,000 in an EIS, deferring the Capital Gains Tax bill and obtaining a £180,000 Income Tax credit. Your net investment is therefore the original £420,000 gain.
When you die, your grandchildren receive the full £600,000 investment assuming zero growth or loss in the investment values, with no Inheritance Tax to pay. More than three times what they would have received if you had not invested in an EIS!
Whether you are looking to save Income Tax, Capital Gains Tax, Inheritance Tax, or all three, an investment in a portfolio of EIS and SEIS shares is well worth considering, as long as you are fully aware of the risks.
At Beavis Morgan we work across a broad range of sectors, advising entrepreneurial people with business ideas and an appetite for financial growth. To find out more about EIS and SEIS investments, as well as other tax planning opportunities, please contact Steve Govey or your usual Beavis Morgan Partner.