9 common questions on EIS investing

Though a well-established scheme that has facilitated over 32,000 early-stage businesses and raised circa £24 billion since its introduction, there remain some specific aspects of the Enterprise Investment Scheme (EIS) that many investors are still unsure of.

The EIS is among the most generous, tax-efficient schemes available to investors interested in supporting high-growth startups in their development (its tax reliefs being renowned as some of the most attractive in the UK venture capital space). Therefore, possessing a developed understanding of the EIS's features is crucial in order to utilise the scheme to its maximum.

With that in mind, these are the 9 questions we are most frequently asked about the EIS.

1. How are EIS dividends taxed?
2. Are EIS investments exempt from Inheritance Tax (IHT)?
3. Can companies invest into EIS opportunities?
4. Can EIS relief be carried back?
5. What is Capital Gains Tax (CGT) deferral?
6. What are the rules around the EIS and knowledge-intensive companies?
7. Are EIS investments covered by FSCS?
8. How does EIS loss relief work?
9. What happens if I dispose of my shares before holding them for three years?

1. How are EIS dividends taxed?

Whilst the EIS offers a number of attractive tax incentives when investing into early-stage companies – including up to 30% income tax relief and loss relief – if dividends are paid these are taxed as normal.

However, it is worth noting for the early-stage businesses that qualify for EIS investment, dividends are rarely paid, as the main income is generally reinvested into the company to fuel further growth.

This is one key difference between EIS and Venture Capital Trusts (VCTs), as dividends on up to £200,000 from VCT investment are income tax-free.

2. Are EIS investments exempt from Inheritance Tax (IHT)?

While not immediately eligible for exemption, as with most of the reliefs that are granted through EIS, shares in EIS-eligible companies will generally become IHT exempt after being held for two years.

This is because, generally speaking, these shares qualify as eligible property for Business Property Relief (BPR) and as a result will become up to 100% IHT exempt after two years of holding.

It is also worth noting that the shares continue to be owned by the investor, so will still be included in their estate, meaning there is no need to relinquish control to qualify.

3. Can companies invest into EIS opportunities?

Companies are able to invest into EIS-eligible companies, but the reliefs are only available to individuals.

As a result, anyone wishing to claim the tax reliefs offered through EIS opportunities must invest as an individual investor rather than through a company.

4. Can EIS relief be carried back?

Yes, it is possible to carry back EIS reliefs. EIS income tax relief can be claimed as though you made the investment in the preceding tax year, meaning you can claim back the tax that was paid in that tax year.

This can be particularly useful if you invest into an EIS-eligible opportunity towards the end of a tax year when it is technically too late to include the investment on your tax bill for the current year, as you will not miss out on your reliefs.

5. What is Capital Gains Tax (CGT) deferral?

You do not have to pay capital gains tax immediately if you use a gain from the sale of any asset to make an investment into an EIS-eligible company. You can defer gains of any size, made up to three years before and one year after the EIS investment.

You will need to pay the capital gains tax when you dispose of the investment, the investment is cancelled or repaid, or the company stops meeting the scheme conditions.

6. What are the rules around the EIS and knowledge-intensive companies?

In April 2018, the EIS allowance effectively doubled, as it is now possible to invest up to £2 million in EIS opportunities provided at least £1 million of that is invested into knowledge-intensive companies.

As well as this, knowledge-intensive companies are able to receive up to £10 million per year in EIS funding, up from £5 million for non-knowledge-intensive companies.

A knowledge-intensive company is, broadly speaking, a young and innovative company that is investing heavily in research, development or innovation.

There are specific HMRC-set requirements a business must meet to be categorised as knowledge-intensive. Firstly, when it issues shares, the company must:

have spent at least 15% of its operating costs on research and development or innovation in one of more of the previous three years; or
have spent at least 10% of its operating costs on research and development or innovation in each of the previous three years

In addition, the business must meet either the “innovation” or “skilled employee” condition. The former requires a company to be creating or having recently created intellectual property that will be used for its main business activities. The latter requires at least 20% of the company’s employees to hold postgraduate degrees in a subject relevant to their job and engaged in research and development.

7. Are EIS investments covered by FSCS?

Unlike savings accounts or other deposit accounts offered by high street banks, investments into unlisted shares are not covered by the Financial Services Compensation Scheme (FSCS). Therefore, you couldn’t claim via the FSCS should an EIS investment fail.

Although these investments aren’t covered by FSCS, platforms and brokers offering investment into EIS eligible companies should be FCA authorised. This means that if the investment is not completed in a compliant way due to the neglect of the service provider, you could be compensated out of the FSCS, established and operated by the FCA.

8. How does EIS loss relief work?

While EIS investments are not covered by the FSCS, there is some protection from loss in the form of EIS loss relief. If EIS shares are disposed of at any time for a loss, this can be set against the investor’s capital gains or income tax liability. This loss relief can be claimed either in the year of disposal or the previous year.

In the case that it is offset against income, the loss relief is claimed at the marginal rate of tax (20% for basic rate payers, increasing to 40% or 45% for higher and additional rate payers). The net effect is to limit the investment exposure to 38.5p in the £1 for a 45% taxpayer, if the shares were to essentially become worthless.

Alternatively, if the losses are offset against capital gains, the relief is applied as a capital loss in the same year, or carried forward to future years.

9. What happens if I dispose of my shares before holding them for three years?

EIS shares require you to hold them for three years to claim the full tax reliefs, but it may be possible that your shares are disposed of before this time, due to the company being sold.

If this happens, the relief that was claimed at the point of investment will be taken back by multiplying the sale proceeds by the rate of relief obtained. The HMRC cannot take back more than the original relief, therefore if the shares are sold at a profit the full relief will be withdrawn.

Exploring the Enterprise Investment Scheme

A generous and highly tax-efficient scheme, the EIS has much to offer, and understanding the specifics and the lesser known features are imperative.

At GCV we have a range of EIS-eligible opportunities now live –  and with more to come – you can explore them here.