Enterprise Investment Scheme (EIS): Definition & Overview

KEY TAKEAWAYS

• The Enterprise Investment Scheme (EIS) is a UK-based investment program to make it easier for small businesses to raise further capital.
• It works by offering potential investors tax breaks if they invest in EIS companies. 
• The EIS grants investors a 30% share of whatever they invest in EIS companies. This has a maximum of either £1,000,000 or £2,000,000, depending on the type of company.

What Is an Enterprise Investment Scheme (EIS)?

The Enterprise Investment Scheme (EIS) is an investment program. It is a scheme based in the United Kingdom that makes it easier for riskier, smaller companies to raise sufficient capital. 

The EIS helps these risker companies by giving their investors federal tax relief. This acts as an incentive to investors, making purchasing these companies’ shares a more appealing prospect.

Working Process of the EIS Scheme

The Enterprise Investment Scheme works by providing 30% of what the investor pays for the shares as a credit. This credit then reduces the investor’s individual income tax owed for the year that they purchased the shares. 

Any taxpayers that use this scheme can claim tax relief of 30% on investments up to £1 million. This is raised to a maximum of £2 million if the money is invested in a knowledge-intensive company.

In addition to this tax credit, the EIS also eliminates the capital gains tax on the shares that are purchased when the investor decides to sell these shares. An interested investor can purchase the shares of the qualifying company directly from the original buyer or through an EIS fund. 

What Kind of Companies Qualify for the EIS Tax Relief?

In order to qualify for this type of tax relief, both the company and its investors must follow a number of specific regulations. These extensive EIS regulations are put in place to prevent investors and companies from abusing the law and subverting its goal. This is of course to encourage investment in small businesses.

One of the regulations for investors is that they must pay for the shares at the time they receive them. Any shares that are issued without payment or with a delayed payment are ineligible to receive EIS tax relief. 

Any investor must hold the shares for a minimum of three years. And any purchased shares must be ordinary shares that don’t preferentially protect the investor from the risks associated with investing in the company. 

The EIS also does not allow any investments that are made purely with the focus of providing tax relief for the investor. The EIS also will exclude any individual with controlling financial interest in a company from receiving the tax relief. Any partners, employees, or directors are also excluded from this benefit. 

With that being said, the EIS does allow an exception. And that applies to angel investors. 

Angel investors are investors that put their money into small entrepreneurs or small startups. They are commonly made up of the entrepreneur’s friends and family. Angel investors are mainly considered to be investing in the person themselves, rather than the business’s viability. They are therefore considered to be the opposite of venture capitalists and are given an exemption. 

Companies can qualify to raise funding through the EIS if they fit the following criteria: 

• Made their first commercial sale less than 7 years ago.
• Have less than a total of £15 million in gross assets. 
• Employ less than 250 people. 

How Much Can I Invest in EIS?

The maximum amount that you can invest in EIS is £1 million per tax year or as we stated earlier, £2 million if investing in knowledge-intensive investments. 

In theory, it is possible to invest more. But you wouldn’t qualify for income tax relief on anything in excess of the maximum amount. However, you would still qualify for capital gains deferral and inheritance tax (IHT) relief.

What Returns Could EIS Investments Offer?

EIS investments can return four separate types of tax relief:

• Income tax relief
• Capital gains tax relief
• Loss relief
• Capital gains tax reinvestment relief

Let’s take a closer look at each of these types. 

Income Tax Relief

There is no set minimum investment that you can pay through EIS in a single company in a tax year. You can gain a tax relief of 30% on investments up to £1 million. This can equal a tax reduction of £300,000 in one year. 

If investing in a knowledge-intensive company, you get a maximum investment of £2 million. Meaning you could see a tax reduction of £600,000 in one year. HMRC has a strict definition of what a knowledge-intensive company is, with conditions that make it a very rigid structure. 

Any EIS allowance is allocated to each individual person, not on a per-household or marital basis. So a married couple could invest up to £2 million in an individual company each and be eligible for Income Tax relief. The main limitation for this is that all shares have to be held for a minimum period of three years from the date of issue. 

Capital Gains Tax Relief

Any capital gain is Capital Gains Tax (CGT) free though this is only if the shares are held for a minimum of three years and the income tax relief on the shares has been claimed. Shares can be held for a longer period of time and potentially give you the ability to accrue a CGT exemption. This makes it an attractive option. 

Loss Relief

If any shares are disposed of at a loss, an investor can choose to set the amount of loss against their income of that year or the previous year. Though this is the loss minus the Income Tax relief. This can help to avoid any situations where the loss is set against capital gains, giving the investor far more flexibility. 

Capital Gains Tax Reinvestment Relief

Payment of capital gains tax (CGT) can be deferred if the amount that is gained is then reinvested into shares of an EIS-qualifying company. The investment has to be made either one year before, or three years after the gained amount arose. This is whether or not the investor has any form of connection to the company. Any unconnected investors can be eligible for relief from both CGT deferral relief, as well as income tax. 

What Are the Key Risks of EIS Investments?

It’s important to understand that any investment involves risk. This is especially true if you are investing in a start-up or early-stage business. 

As the EIS is specifically for smaller, riskier companies, this risk is magnified. These companies can suffer due to a lack of dividends, illiquidity, loss of investment, or dilution. Therefore, it is recommended that EIS companies should only be invested in to round off an already diversified portfolio.

Summary

The EIS is a great initiative to encourage investors to buy the shares of smaller companies. It helps to stimulate growth within the business sector and goes some way to boosting the economy – especially if these smaller companies start to see a good level of success and growth. 

It also works for investors, who can potentially make money through their long-term investment decisions whilst also seeing a tax benefit, via relief against their income tax liability.