What are the rules of EIS investments?

The Enterprise Investment Scheme (EIS) is designed to encourage private investment into growing British companies, by offering attractive tax reliefs.

It is one of the UK Government’s flagship policies for supporting British enterprise, stimulating approximately £1bn of private investment each year. For anyone considering investing in to the EIS scheme, there are a number of EIS rules they need to take into consideration.

What are the rules of EIS investments?

EIS offers investors a multitude of tax reliefs. However, there are some important EIS investment rules that both investors, and the founders of the companies themselves need to adhere to. Below are some of the most frequently asked questions around EIS scheme rules:

How long do I need to hold EIS shares?

• There are two key time frames that EIS investors need to be aware of that fall within the EIS rules for investors:
  • In order to retain income tax reliefs, the EIS shares need to be held for a minimum of three years, from the date of ownership. It is possible that the shares in the business could be disposed of within this period due to the company being sold, and should this eventuality arise, the original tax relief provided by HMRC can be clawed back.
  • In order for the EIS qualifying shares to benefit from Business Relief, they need to be held for a minimum of 2 years from the date of purchase, and still need to be held on the death of the owner. If this happens, the value of the shares will be exempt from IHT. However, should the owner die within the two year holding period, the value of the shares will form part of his/her estate for IHT purposes.
• There is often confusion between the minimum holding periods listed above, and the lifecycle of EIS investments. Although the minimum holding period is three years, in reality an investor should expect to hold EIS shares for at least 5-7 years, and in some cases longer.

Can an Investor be a director?

• EIS rules are not intended to discourage investors who would like to become directors of the company (or a subsidiary of the company) they invest in. Quite often, investors have business expertise that can benefit the investee company. These investors are often known as “business angels”. Business angels are allowed to qualify for income tax relief despite the fact that they receive payment for their services. However, EIS scheme rules around this subject are strict, and only apply where:
  • The only way the individual is connected with the company following investment, is in the role of a director, who receives, or is entitled to receive remuneration, and at the time the shares are issued, the director in question has never before been connected with the company in any way.
  • Remuneration, for this purpose includes items such as benefits, and remuneration must be reasonable in amount.

Can I invest in my own EIS company?

• HMRC has strict EIS rules for investors looking to invest into their own company. The investor cannot be “connected” to the company. An individual is deemed as having a connection with the issuing company if he or she, or any associate of them is:
  • An employee
  • A partner, or an employee of a partner
  • A director (except from where a director receives, or is entitled to receive, remuneration)
  • A director of a company which is a partner of the company, or of any company which is at any time a subsidiary of that company
  • An individual is connected with a company if he or she, whether alone or with an associate directly or indirectly possesses or is entitled to acquire more than 30% of the ordinary share capital of the company or any subsidiary.

Can family invest in EIS?

• Another EIS investment rule is the connected parties rule. This restricts the ability of certain family members from investing into a company via EIS. Relatives, under connected party rules are defined as spouses and civil partners, parents and grandparents, children and grandchildren.
• This means that there is some scope for investment by a limited number of family members – brothers and sisters, aunts and uncles, nephews and nieces, unmarried partners and in-laws are all free to invest, and benefit from the EIS tax reliefs.

Can companies invest in EIS?

• Companies can invest into EIS qualifying companies. However, EIS scheme rules stipulate that the associated tax reliefs are only available to individuals.
• The tax treatment between a corporate and individual application is different – if a company makes a corporate application, they will be able to do so without any initial liability to tax, and it is a good way of extracting accrued capital from the balance sheet. However, as such an application benefits the company, the underlying investors will not benefit from the associated tax reliefs afforded to individual investors. Therefore, it may be beneficial to determine the overriding objectives of the investment, and whether individual income tax relief, EIS CGT deferral, tax-free gains, and IHT relief are a reason for looking at an investment of this type. If it is, it may be beneficial to extract individually, pay the tax, then claim back and benefit from all the other EIS tax benefits.