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EIS tax relief…income tax relief focus

Mark Bower-Easton, Business Development Manager, Oxford Capital

When you invest into an EIS fund you are investing in to early-stage businesses. There is no getting away from the fact that investing in such assets are a high-risk strategy. Fortunately, HMRC realise this, and as a reward for investing in companies of this ilk, they will provide investors with some attractive tax reliefs. Over the coming weeks we will be examining each relief in detail and will provide a case study to illustrate how an EIS can be used to help mitigate a number of tax issues that UK resident investors can be faced with. Let’s start with Income tax relief.

The rules:

  • Assuming you are a UK resident, you can invest up to £1m per tax year in to an EIS. If the fund you are investing in is classed as “Knowledge Intensive” the annual contribution limit is £2m. If you want to, or need to, you can also backdate the contribution by one tax year, so assuming you haven’t made a contribution in to an EIS fund in the previous tax year, your annual contribution limit is effectively doubled. Income tax relief is provided at 30% of the invested amount.
  • Each company invested in to will issue shares in the investors name and will register the holding with HMRC. HMRC will in turn provide investors with EIS3 Certificates. Upon receipt of the EIS3 certificates you can claim your tax relief via self-assessment. HMRC will grant income tax relief to the value of 30% of the amount used to purchase shares. If a client invests £100,000 in to EIS eligible shares, they will receive EIS3 certificates which they could use to offset £30,000 of their income tax bill. It is important to note that in order to make full use of the income tax relief, your income tax liability needs to at least match the amount of tax relief – if you get £30,000 tax relief but only have a tax liability of £15,000, HMRC won’t be popping you a cheque for the other £15,000 in the post.
  • In order for the tax relief to be maintained, the qualifying shares need to be held for at least three years. If disposal occurs before the end of the third year, HMRC will claw back the tax relief already provided.
  • Some EIS funds provide investors with EIS5 certificates instead. These certificates consolidate all share holdings in to just one certificate. However, these types of certificates are incredibly rare.

Now we have established the basics, let’s take a look at how income tax relief can work in practice by way of a case study, on Mrs Smith. She will be the focus of all of the case studies over the coming weeks.

Mrs Smith is 55, married, a UK resident/non domicile, and works for an investment bank. She earns a basic salary of £165,000 and has just received an annual bonus totalling £110,000, bringing her annual renumeration up to £275,000. She pays 5% of her basic salary into her company pension scheme, which is matched by her employer. She is approaching the lifetime allowance and anticipates that she will hit the £1,073,100 threshold in this tax year. She has approximately £700,000 sitting in a cash savings account.

She pays £55,498 income tax on her basic salary, and an additional £47,025 on her annual bonus, giving an annual income tax liability of £102,523 from her employment.

She has spoken to her financial adviser, who has advised her of the risks (a summary of which you can find here: EIS Risk Information) and has recommended an EIS to help offset part of her income tax bill. She has confirmed to the adviser that her attitude to investment risk is high, and that she is a sophisticated investor. She is looking to invest £200,000 of her accumulated savings in to an EIS.

This £200,000 investment will provide her with £60,000 income tax relief, which can be claimed via self-assessment, using EIS3 certificates as evidence. As a result of this investment, the amount of income tax paid would have reduced from £102,523 to £42,523.

If Mrs Smith wanted to reduce her income tax liability to zero, she would need to invest £341,750.

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