Mark Bower-Easton, Business Development Manager, Oxford Capital
The government has been promoting private investment in to early-stage businesses via the Enterprise Investment Scheme (EIS) since 1994, and it shouldn’t be underestimated just how important entrepreneurial businesses are to the UK economy.
While EIS are high risk investments – you are investing into companies based on potential rather than track record, in return they offer investors the potential for growth, plus some generous tax reliefs, courtesy of HMRC.
Following on from our recent blog focusing on income tax relief, I will now focus on Capital Gains Tax (CGT) Deferral Relief. Again, I will be examining the rules around this relief and our case study Mrs Smith will be making another appearance. The case study will be used to illustrate how an EIS investment can be used to help mitigate a number of tax issues that UK resident investors may face, including today’s main topic, CGT Deferral Relief.
- When you dispose of an asset and make a gain you will usually pay CGT for the tax year in which the asset is disposed. In the 2021-22 tax year each individual has a CGT allowance of £12,300. This is the amount of gain you can realise in this tax year without giving rise to CGT. On the gain exceeding the annual allowance a basic rate taxpayer will be liable to CGT at 18% on property (excluding main residence) and 10% on other chargeable assets. A higher rate taxpayer will be liable for 28% CGT on property (excluding main residence) and 20% on other chargeable assets. If an asset is jointly owned, you can both make use of your individual allowances, effectively doubling the gain you can make before CGT becomes due.
- Deferral relief allows you to treat the gain as not arising until some date in the future – as long as you purchase EIS qualifying shares with the realised gain. Effectively, the gain can be deferred indefinitely, and will disappear completely if the EIS qualifying shares are still held upon death. Unlike every other UK tax, CGT is the only tax where the liability dies with you. If you sell the EIS qualifying shares during your lifetime and do not reinvest in to further EIS qualifying shares, the deferred capital gain will become payable.
- If you obtain income tax relief via an EIS investment, you can still claim the other tax reliefs such as CGT Deferral Relief. If you have a large CGT liability but no income, you are able to claim CGT Deferral Relief without claiming income tax relief.
- The EIS shares you use to defer the CGT liability must be issued to you in the period beginning one year before, and ending three years after, the date of disposal for which you wish to claim the relief. As an example, if you were to dispose of an asset on 1st June 2021, you can claim deferral relief against this gain if you subscribe for, and are issued, EIS shares at any time between 1st June 2020 and 1st June 2024.
- You can claim CGT Deferral Relief if you are an individual resident of the UK.
- CGT Deferral Relief is claimed via the capital gains tax summary section of your self-assessment tax return and can be claimed upon receipt of your EIS3 certificates (the same certificates used to receive income tax relief). There is a time limit for claiming CGT Deferral Relief, and this is 5 years after the first 31st January following the end of the tax year in which the EIS qualifying shares were issued.
Now we have established the main rules, let’s take a look at how CGT Deferral Relief can work in practice by way of a case study, on Mrs Smith. She was the focus of our recent income tax relief case study and will be the focus of all our case studies over the coming weeks.
As a reminder, Mrs Smith is an additional rate taxpayer, aged 55, married and is UK resident/non-domiciled.
Four months after agreeing to invest in to an EIS fund with the aim of achieving capital growth and income tax relief, Mrs Smith and her financial advisor conducted a review meeting. During the meeting Mrs Smith mentioned that she had recently sold a number of directly held shares, which had realised a significant capital gain. The purchase price for the shares was £30,000, and the sale value totalled £100,000, a capital gain of £70,000.
Mrs Smith confirmed to the advisor that they were held solely in her name, and that she had not realised any other capital gains in this tax year, so had her full CGT allowance of £12,300 intact.
The advisor calculated that the amount of the gain liable to CGT on the shares is £57,700 (£70,000 gain minus annual allowance of £12,300), upon which CGT would be payable at 20%, meaning a CGT bill of £11,540. Mrs Smith’s advisor mentioned that she could defer payment of capital gains tax by investing the capital gain, minus her annual CGT allowance, of £57,700 in to an EIS. This would defer the capital gain all the while the money is invested in to an EIS and could potentially defer the gain indefinitely. It would also provide an additional £17,310 in income tax relief via self-assessment.
In summary, without investing the proceeds of the share sale in to an EIS fund, Mrs Smith would have been liable to paying CGT at 20% on the excess gain above her annual allowance, due to her being an additional rate taxpayer. Mrs Smith has therefore managed to defer a CGT bill of £11,540 by investing the £57,700 in to an EIS, and has received further, significant relief on her income tax liability.
As long as Mrs Smith continues to hold the EIS qualifying shares, the CGT liability will not become due, and if she holds the shares until death, no CGT will be payable by her estate.