Enterprise Investment Scheme – tax reliefs in practice
Application of the tax reliefs offered by Enterprise Investment Schemes
In Enterprise Investment Schemes – what tax reliefs are available? Here we look specifically at the tax reliefs available to individuals who choose to invest in an Enterprise Investment Scheme (EIS).
We often receive queries around how these tax reliefs are applied in practice so thought it would be a good opportunity to illustrate this in a bit more detail.
Case study
Gerald is a Finance Director and earns £200,000 a year. In August 2022, he sold his entire taxable portfolio and realised a capital gain of £260,000.
Given Gerald’s earnings, he would lose full entitlement to his personal allowance. As a reminder, the personal allowance is reduced by £1 for every £2 once total income exceeds £100,000. This means that for the current tax year the personal allowance is fully lost once total income is in excess of £125,140.
With regard to the capital gain, the whole amount after taking account of his capital gains tax (CGT) annual exemption (AE) of £12,300 – i.e. £260,000 – £12,300 = £247,700 – would be taxable at the CGT higher rate, so 20%. (Please note that the AE will fall to £6,000 for 2023/24 and to £3,000 for 2024/25.)
Gerald’s tax position is therefore as follows:
Taxable Income: £200,000
Income Tax Liability:
£37,700 x 20% = £7,540
£112,300 x 40% = £44,920
£50,000 x 45% = £22,500
Total Income Tax: £74,960
Capital gain = £260,000
less AE = -£12,300
Total Taxable Capital Gain: £247,700
Capital Gain Tax Liability:
£247,700 x 20% = £49,540
Overall tax = £124,500
(Please note, from 6 April 2023, the threshold above which the 45% rate is payable will fall from £150,000 to £125,140.)
Gerald is looking for ways in which he can carry out some planning in order to reduce the amount of tax payable.
After seeking some advice, he decides to subscribe for new ordinary shares in an EIS as he is aware that this type of investment would enable him to defer his capital gain and also benefit from income tax relief against his tax liability.
He decides to use his annual exemption and defer his taxable capital gain of £247,700 into an EIS.
Gerald’s revised tax position is therefore as follows:
Revised Income Tax Liability:
£37,700 x 20% = £7,540
£112,300 x 40% = £44,920
£50,000 x 45% = £22,500
Total Income Tax: £74,960
Less income tax relief: -£74,310*
Revised Total Tax = £650
*£247,700 x 30%
Had he deferred his whole capital gain he would have benefitted from income tax relief of £78,000 (i.e. £260,000 x 30%). However, as mentioned above, he can only benefit from income tax relief based on his actual tax liability which is £74,960.
The company must remain qualifying and Gerald has to hold the shares for at least three years otherwise the income tax relief would be withdrawn.
Ordinarily, on future sale of the EIS shares, Gerald’s deferred gain would come into charge, whereas if he retains the shares until death the deferred gain is fully eliminated. And, provided he has held the shares for at least two years, on his death, the shares will qualify for 100% business relief and thus be free of IHT. (Note that even if the EIS company loses its qualifying status, provided it remains an unquoted trading company, that is carried on for profit (and is not one of “wholly or mainly” dealing in securities, stocks or shares, land or buildings or in the making or holding of investments), the shares can still qualify for IHT business relief.)
If Gerald’s taxable gain had instead been from the sale of a residential property (such as a buy-to-let), as a result of the 60-day payment rule that now applies to CGT arising on the disposal of residential property, he may have had to pay the CGT and then recover it later when the EIS investment is made and CGT deferment relief is claimed.
A note of caution
EIS investment is considered risky as investment is being made into small companies, so it is vital that such investment is in line with your risk profile. Professional advice should be sought.
Credit: Techlink
