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Five reasons to invest in an Enterprise Investment Scheme

Tahmina Mannan
Written By:
Tahmina Mannan
Posted:
Updated:
27/11/2013

We look at how Enterprise Investment Schemes can offer savvy investors a tax efficient investment solution.

When it comes to tax planning, many of us don’t get beyond thinking about the benefit of making extra pension contributions ahead of the tax year end or the balance of assets and income between a husband and wife.

But Enterprise Investment Schemes, or EIS as they are usually known, offer a number of ways in which the savvy investor can combine investment benefits with some significant government approved tax reliefs.

EIS were introduced by the government in 1994 to encourage investment into the UK’s smaller companies.

EIS are a tax-efficient way to invest in the new shares of small businesses, as well as being a critical source of funding for these businesses.

Through supporting smaller companies, the tax and planning benefits that an EIS investment can offer can make it a great option for some investors. Using an EIS, investors can address a number of tax liabilities through just one investment product.

John Thorpe from Octopus Investments runs us through the benefits of investing in an Enterprise Investment Scheme.

Income Tax Relief

To start with there is 30% income tax relief on your investment. So for every £50,000 you invest, £15,000 can be claimed back from tax that you pay.

Capital Gains Tax Deferral

If someone sells their business, a share portfolio or a second home then the gain in value, above the annual limit of £10,900, is taxed at a rate of up to 28%. Invest the gain into an EIS and this capital gains tax (CGT) can be deferred while the EIS investment is held.

Furthermore if the EIS is held at death, then the CGT liability is eliminated enabling the full value of the EIS to be passed on to loved ones.

100% Inheritance Tax Relief after two years

The value of an investment in an EIS is exempt from inheritance tax (IHT), provided it’s been held for at least 2 years before, and is held at the time of, death.

Flexibility

None of us have a crystal ball. There are, of course other options available to investors to help manage their inheritance tax issues, the most common one being to put money in trust. But this doesn’t provide the upfront income and capital gains tax benefits of an EIS.

And, significantly, once you put your money in a trust, you lose control of your assets. With people living for longer and not knowing if they will need care later in life, many investors want greater flexibility and the opportunity to retain access to their funds.

Loss Relief

Loss relief is one of the most compelling features of investment into an EIS, because the impact of losses at an individual company level is reduced. This loss relief significantly improves the overall post-tax risk/return profile of the investment.

For most investments, investors have an allowable loss when shares fall in value. However when they go up in value, investors must pay capital gains tax.

Within an EIS, each individual holding is assessed separately for loss relief. This means that any holding that has fallen in value at the time of sale will qualify for loss relief irrespective of the overall portfolio performance. Even if only one holding within a portfolio of ten investments falls in value, investors are entitled to loss relief on that one holding.

An EIS becomes a particularly attractive investment solution when an investor can benefit from two or more of these incentives, as they can both be used at the same time. For example, an investor can use EIS to defer a capital gain, or perhaps mitigate it through holding the EIS until death, while also making an investment that’s free from IHT.

For the retired wealthy, perhaps still with reasonable levels of income, there may even be an income tax saving to be made as well.

So what are the downsides?

Investing in smaller companies by definition carries more risk, and by their nature tend to be more illiquid. They can’t be bought or sold as quickly and easily as shares trading on the FTSE for example.

However, fund managers specialise in finding opportunities for investors where the risks and liquidity are carefully managed and the wide variety of opportunities in the UK small business space means there are many ways for an EIS to meet the needs of investors, whether they are seeking high growth or more predictable, risk mitigated returns.