If you are looking to take advantage of tax efficiency schemes through investment in early-stage businesses, then whether you’re an investor or a founder, The Enterprise Investment Scheme (EIS) could be exactly what you need.
The government scheme was designed to make it more appealing to support exciting UK businesses, by offsetting some of the associated risk through offering tax reliefs to investors who purchase shares in these companies.
There can be significant benefits for those looking to take advantage of such a scheme; for founders who might otherwise take longer to secure funding for their business, and for investors who can reap the rewards of investing in a new company and pay a smaller amount of tax on any returns.
In this ultimate guide, we’ll explain everything you need to know about EIS, explore the benefits of investing in EIS eligible companies, as well as considering the risks involved, and the key rules for both investors and founders.
What is EIS?
The Enterprise Investment Scheme (EIS) is a government-backed scheme that aims to help smaller companies raise finance by providing tax reliefs to investors who purchase shares in these companies. The scheme was introduced in 1994 and has since become one of the most popular tax-efficient investment schemes in the UK.
EIS for Investors
What are the benefits of EIS?
One of the main benefits of EIS investment is the potential to receive significant tax reliefs. There are a number of different types of tax relief available under the scheme, including;
Income Tax
- The relief is given at rate of 30%
- The maximum amount that can be up to £2 million per tax year. However, any amount over £1 million must be for shares invested into a Knowledge Intensive Company. You can learn more here
Capital Gains Tax
- When disposing the shares they are free from capital gains tax.
- Deferral relief is available when an asset is disposed of and allows deferring the gain to some later time. You can learn more here.
Loss Relief
- Available if the EIS investment fails, allowing investors to offset losses against their income or gains for tax purposes.
Inheritance Tax Relief through Business Property Relief
- Shares issued through EIS scheme qualify for Business Property Relief. This means that shares can be left for beneficiaries free from inheritance tax. To use the relief shares need to be held for at least two years at the time of death.
What are the EIS Rules for investors?
In order for Investors to benefit from these generous tax breaks, they first meet certain eligibility rules in order to qualify for this relief;
- Pay income tax in UK and be over 18
- Hold shares for a minimum of three years
- Hold no more than 30% of the company’s shares
- Not be employed by the company unless they’re a director
- The scheme cannot be used for tax avoidance purposes
- Must not receive any benefits from the company other than their return on investment.
How Do You Invest in EIS Companies?
Investing in EIS companies can be done through a range of platforms and investment providers. Some investors choose to invest directly in individual companies, while others prefer to invest through EIS funds or trusts.
If you are an investor looking to benefit from some of these tax relief schemes, you can explore EIS eligible businesses that are currently raising capital on Seedrs now.
How Much Can You Invest in EIS?
The maximum amount an investor can invest in EIS-qualifying companies is £1 million per tax year. This includes any investments made in EIS-qualifying companies through EIS funds or trusts.
How Long Do You Have to Hold EIS Shares?
To be eligible for EIS tax relief, investors must hold the EIS shares for at least three years from the date of issue. If the shares are sold before this time, the tax relief may be clawed back by HM Revenue & Customs.
Risks of EIS Investments
- High risk: EIS investments are considered high risk and are therefore not suitable for all investors. Investing in early-stage companies can deliver significant returns but that comes with an increased level of risk and there is a higher chance of losing all of the investment than with more established businesses.
- Illiquid investment: EIS investments are typically illiquid, meaning that it can be difficult for investors to sell their shares and get their money back. It is important to consider the long-term nature of the investment and whether you can afford to tie up your money for a number of years.
- Potential for fraud: As with any investment, there is always a risk of fraud. Investors should carry out due diligence on any EIS investment opportunities and ensure that the company is legitimate and has a viable business plan.
How Do You Claim EIS Tax Relief?
- Company Issuing Shares should provide with EIS3 form to the investors
- Investors must complete a self-assessment tax return and include details of the EIS investment. The tax relief will then be deducted from the investor’s income tax liability for the relevant tax year.
Please note that professional advice should be sought in completion of any financial processes.
EIS for Founders
The primary benefit of EIS for founders is that it can provide a source of funding for early-stage businesses that are often unable to secure traditional financing from banks and other institutional investors. EIS funding can help founders to:
- Raise capital: EIS can provide startups and small businesses with a valuable source of funding to help them grow and expand.
- Attract investors: EIS can make it easier for businesses to attract investment from individual investors who are attracted by the significant tax relief on offer.The number of investors claiming Income Tax relief on Self Assessment forms under the EIS has increased, from 36,150 in tax year 2019 to 2020 to 37,535 in 2020 to 2021.
- Maintain control: Unlike other forms of financing, EIS does not require founders to give up control of their business to outside investors.
- Attract top talent: The availability of EIS funding can help businesses to attract top talent by providing a valuable incentive for employees to join an early-stage business.
Company Eligibility
To be eligible for EIS, a business must meet a number of criteria. These include:
- Being a UK-based company
- Having fewer than 250 employees
- Having assets of no more than £15 million
- Not being listed on a recognised stock exchange
- Not being controlled by another company
- The lifetime value of investment can’t be more than £12 million
- Not trading for more than seven years (ten years for a knowledge-intensive company unless specific conditions are met
- The company must not be trading in an excluded activity, such as trading in property investment, financial services, leasing, receiving Royalties, nursing homes or energy generation
However, if a company has been trading for more than 7 years, the company may be eligible to fall under condition A or B of S175A Income Tax Act 2007. The conditions act as an exception to the 7 years rule.
What types of shares are eligible for EIS relief?
To be eligible for EIS relief, shares must be newly issued, fully paid-up, and held for at least three years. In addition, the shares must be ordinary shares and cannot carry any preferential rights. It’s important for founders to work with a qualified accountant or tax advisor to ensure that they meet the eligibility criteria for EIS relief.
What is a Knowledge Intensive Company (KIC)?
A Knowledge Intensive Company (KIC) is a type of business that is engaged in the creation of intellectual property or the use of technology to create new products or services. KICs are eligible for additional tax relief under EIS, which can make them a particularly attractive investment for investors.
To be eligible for KIC status, a business must meet a number of criteria. These include:
- If the business uses IP to create products that would become the main revenue generating product in the next 10 years or creates IP technology.
- At least 20% of employees received higher education and work for you in the same field of their education.
- A sufficient amount of operating costs is spent on research and development.
How does your business get EIS funding?
To attract EIS funding, businesses typically work with a network of angel investors, venture capitalists, and crowdfunding platforms. To maximise the chances of securing EIS funding, businesses should be prepared to present a detailed business plan and financial projections that demonstrate their growth potential.
What is the EIS Risk to Capital Condition?
The EIS Risk to Capital Condition is a test that is applied to EIS investments to ensure that they are being made with the aim of generating long-term growth rather than simply providing a tax break. To meet this condition, EIS investments must carry a significant risk of loss and be made with the intention of achieving capital growth.
The application to EIS for founders
- You can apply for Advance Assurance. It is not obligatory, but Advance Assurance is official confirmation from HMRC that investment in your company is likely to qualify for EIS tax relief which can be very helpful, as it will show investors that you already have confirmation from HMRC.
- Complete Compliance Certificate.
- You receive EIS2 which is authorisation for investors to apply for tax reliefs (see more here.)
Are you a founder and looking to raise funds through the crowd?
UK tax payers should note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. To learn more about how SEIS or EIS works, please read the online HMRC guidance or contact a professional tax advisor.
