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EIS Income Tax Relief: What does it entail?

EIS Income Tax Relief

Embarking on an investment journey can be both thrilling and complex, especially when delving into the intricacies of the Enterprise Investment Scheme (EIS). Beyond the technical jargon lies a valuable opportunity for investors to not only support early-stage UK companies but also benefit from substantial tax relief. 

In this guide, we’ll unravel the complexities surrounding EIS income tax relief, offering a comprehensive understanding for those new to the concept.

Demystifying EIS Income Tax Relief

At the heart of the EIS lies the coveted income tax relief, a mechanism allowing investors to reclaim up to 30% of their investment in qualifying startups or small businesses against income tax that they have paid, either in the year of investment or carried back against the previous year. 

Picture this: a £50,000 investment could translate into a £15,000 reduction in your income tax bill. While this may sound enticing, the path to claiming this relief requires navigating a few essential criteria.

Navigating Eligibility and Limits

To tap into EIS tax reliefs, investors must meet specific criteria, including UK residency, adequate income tax liability, and a commitment to holding EIS shares for a minimum of three years. 

Am I Eligible to Claim EIS Income Tax Relief?

To claim EIS income tax relief, you must meet the following criteria:

  • Be a UK resident taxpayer: The relief is only available to individuals who reside in the UK or otherwise pay UK income tax.
  • Have sufficient income tax liability: You must have accrued enough income tax in the year of investment or the prior year to claim against. The relief cannot exceed your income tax due.
  • Invest in EIS-qualified shares: The relief only applies to investments made directly into companies approved under the EIS scheme.
  • Hold shares for at least 3 years: You must retain the EIS shares for a minimum of 3 years to maintain eligibility for income tax relief.

In addition, you cannot be an employee or partner of the company you are investing in. Relief is only available for outside investors. 

What Are the Limits for EIS Income Tax Relief?

Apart from this criteria – limits exist, allowing relief on annual investments up to £1 million for most companies and £2 million for knowledge-intensive ventures. This means the maximum tax relief possible per year is either £300,000 or £600,000.

Planning EIS Investments to Maximise Relief

To optimise your tax savings, it helps to plan investments across tax years. For instance, you may stage a £2 million investment into a knowledge-intensive company over 2 years to claim the full £600,000 in tax relief each year.

Proper planning can help high-net-worth investors take full advantage of the generous relief.

Understanding the Risks

While the allure of tax relief is undeniable, it’s crucial to acknowledge the risks associated with EIS investments. Gaining a balanced perspective will help ensure you make an informed decision, recognising that the potential benefits come hand-in-hand with uncertainties linked to early-stage ventures.

  • Startups lack a proven track record, increasing the risk of failure or underperformance.
  • EIS investments are often illiquid, making it challenging to sell or exit holdings quickly.
  • Economic downturns can impact the success of EIS investments, affecting funding and growth.
  • Changes in government policy or tax laws can impact the tax benefits and attractiveness of EIS.
  • Unique risks tied to the nature of the invested business, such as technological challenges or market competition.
  • Investors must commit to holding EIS shares for a minimum of three years.

We recommend potential investors conduct due diligence, consider professional advice, and always ensure they have a clear understanding of risk tolerance.

Claiming EIS Income Tax Relief

Securing your EIS income tax relief involves a step-by-step process. From making a qualifying investment to submitting the necessary documentation to HMRC, the steps below walk you through the journey. 

How Do I Claim EIS Income Tax Relief?

Follow these key steps to claim income tax relief on your EIS investments:

  1. Make a qualifying investment in an EIS-approved early-stage company, either directly or through a fund.
  2. After the share issue, you will receive an EIS3 certificate from the investee company. This certifies your investment qualifies for tax relief.
  3. Send the EIS3 certificate to HMRC alongside your self-assessment tax return or EIS3 claim form.
  4. HMRC will adjust your income tax bill to apply the relief you are eligible for. Expect processing times of 4-8 weeks after you submit paperwork.
  5. Your tax relief will appear either as a reduction in your upcoming income tax bill or as a tax refund via PAYE.

Anticipating Returns and Avoiding Pitfalls

Receiving your income tax relief is a moment of validation for investors. Expect to see the results within 1-2 months after submitting the required paperwork. However, it’s crucial to stay vigilant and avoid common mistakes such as overlooking the 3-year holding period or failing to claim relief within the designated time frame.

Common Mistakes that Prevent Full EIS Relief

Many investors miss out on the full tax relief they are entitled to by making small but costly errors like:

  • Attempting to claim relief as an employee of the EIS investee company
  • Forgetting to claim relief within 5 years of the share issue date
  • Lacking sufficient income tax liability in the relevant tax year
  • Failing to hold EIS shares for the required 3-year minimum period

The Takeaway on EIS Income Tax Relief

In conclusion, while the EIS income tax relief landscape may seem intricate, this guide aims to demystify the process for first-time investors. By understanding the nuances, planning strategically, and navigating the potential risks, investors can unlock the full potential of EIS income tax relief. This can help mitigate the risks associated with investing in early-stage ventures that do not yet have a proven track record.

For further assistance and expert guidance, explore our website’s resources dedicated to helping investors successfully navigate the EIS landscape.

Estimated reading time: 2 min

 

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    1. If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
  2. You are unlikely to be protected if something goes wrong
    1. Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
    2. Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
  3. You won’t get your money back quickly
    1. Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    2. The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    3. If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    1. Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    2. A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest
  5. The value of your investment can be reduced
    1. The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    2. These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

 

If you are interested in learning more about how to protect yourself, visit the FCA’s website here.