Enterprise Investment Schemes – Walking an investment tightrope

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Introduction

In this article, we discuss the merits and pitfalls of the Enterprise Investment Scheme (or EIS for short).

 

As a private investor, you could be in the lucky position of having fully utilized your annual contribution allowances into tax advantaged investment arrangements such as registered pension plans or Individual Savings Accounts (ISAs). If so, you may wish to consider further investment into a scheme that is attractive both for its potentially high returns and generous tax concessions (see Table 1 below).

 

Incentives and risks

Since their introduction in 1994, successive UK governments have offered progressively greater enticements to individuals to pay into Enterprise Investment Schemes. From the 2012/13 tax year, tax relievable investment limits were increased to a generous £1 million (from £500,000) per tax year.

 

So what exactly are these schemes and are they suitable for everyone?

 

A conventional EIS allows investment by an “unconnected” person into the securities of a single trading company which by its nature, poses a significant risk in terms of a lack of diversification and therefore, high exposure to un-systematic risk (the risk in this instance of the company failing operationally). The types of company allowed under these schemes are severely restricted by their size and so, will predominantly be young businesses looking to leverage growth. Unfortunately, these are just the sorts of firms that run the highest risk of failure particularly in their formative years potentially resulting in the loss of most or all of your money!

 

EIS investments often demonstrate a distinct lack of liquidity. The scheme is only open to unlisted companies (AIM shares count as unlisted) so the number of buyers and sellers of their shares in the market will be extremely limited. In addition, many of the available tax reliefs and allowances attaching to them will be lost if the investor needs to access funds within certain minimum periods.

 

Returns

On the positive side, investment into EIS companies at their fledgling stages can provide spectacular investment returns over the medium to longer term. Returns will often be capital growth based but ordinary share investment also allows for payment of future dividends.

 

Conclusion

To summarise, contributing to an EIS is highly speculative. Those not able to tolerate loss of their investment should steer clear of these arrangements even if the tax incentives do appear very attractive. An EIS should ideally form part of a larger portfolio of diversified investments to meet an individual’s objectives over the appropriate term and against an overall acceptable level of risk.

 

Table 1

 

Tax reliefs and incentives of Enterprise Investment Schemes:

  • Income tax relief of 30% of investments up to £1 million (2015/16). Relief will be withdrawn if the EIS shares are disposed of within three years
  • Capital gains from elsewhere can be deferred without limit if reinvested into an EIS within a period beginning one year before and ending three years after the disposal giving rise to the gain. On disposal of the EIS shares, the deferred gain will become chargeable to capital gains tax (CGT) unless re-invested to a new EIS
  • Gains arising from contributions to an EIS that qualified for income tax relief will be exempt from CGT as long as they are held for three years.
  • Capital losses made in EIS can be offset against other income or gains in the year of disposal (subject to minimum three year holding period).
  • Income from dividends arising is subject to income tax in the normal way
  • Subject to two-year ownership period, assets will receive 100% inheritance tax Business Property Relief.

 

 

For more information on qualifying requirements for both investors and businesses being invested in, visit http://www.hmrc.gov.uk

 

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