A common problem faced by many people is how do they pass on their wealth, which they have worked extremely hard to accumulate, to their loved ones without paying any Inheritance Tax.
Whilst in some cases some simple financial planning strategies and future planning can remove any potential Inheritance Tax liability, there are a number of instances where people face the unfortunate position of their desired beneficiaries facing a potential Inheritance Tax liability in the future.
In these instances, there are some strategies and investments available which can help reduce any potential tax liability.
Here we focus on one of the potential solutions, EISs, considering what they are and what benefits they offer investors.
What is an EIS?
An EIS (Enterprise Investment Scheme) is a scheme introduced by the government in 1994 to help small, early-stage companies raise funds and grow. Since launch, 32,965 companies have received investment and around £24 billion of funds have been raised (National statistics published by HMRC 27 May 2021) from investments into EIS’s.
Companies qualifying for EIS funding are small and usually privately owned, although they can be listed on Alternative Investment Market (AIM). They will vary across a range of sectors and industries but will typically have gross assets of less than £15 million at the time of investment and fewer than 250 employees. Some of the business activities excluded from EIS funding include dealing in land, property development and leasing, forestry and operating or managing hotels. Whilst the list of exclusions is fairly long, it still leaves huge scope for investors.
What tax reliefs are available?
Investing in small, early-stage companies is not for the faint-hearted. Whilst some of these companies might do very well, others will struggle, and some will ultimately fail. Therefore, the government provide a range of tax reliefs which essentially act as an incentive to investors as these companies can mature into successful, established companies which create jobs and stimulate the UK economy. The tax relief available potentially reduces the impact should any of the underlying companies not be successful and increases the overall position for those companies which are successful in the future.
The tax reliefs available are as follows:
Income Tax Relief
Investors can claim up to 30% income tax relief on EIS investments up to a maximum investment of £1 million in each tax year. As an example, a £100,000 investment into an EIS could provide a £30,000 saving on that year’s income tax bill. To claim this relief though, the investor must have sufficient income tax liability and hold the investment for at least three years.
As the relief is available in the tax year the investment into the company is made, which may not be in the same tax year as the money is paid to the EIS provider, it is possible to carry back this income tax relief to the previous tax year.
Inheritance Tax Relief
An investment in an EIS should benefit from 100% relief from inheritance tax as the investments qualify for Business Relief. This means that, provided the investment is held for two years and at the time of death, the funds can be left for beneficiaries free from Inheritance Tax.
Capital Gains deferral
Where an investor has realised a taxable capital gain and invests the value of the gain in an EIS qualifying investment, the capital gain can be delayed for as long as the money stays invested and the EIS conditions are not breached.
There are no limits on the size of capital gain which can be deferred, however, the investment into an EIS needs to be made no earlier than 12 months prior to, or three years after, the original capital gain was made. The capital gain will be deferred until the earliest of any of the following events:
- The EIS shares are sold
- The company ceases to be EIS-qualifying within three years of investment
- An investor ceases to be a UK resident within three years of investment
When the deferred gain comes back into charge, it is subject to capital gains tax at the relevant rate at that time. Where an investor die owning the EIS shares, the capital gain will be eliminated.
Tax Free Growth
When investors sell EIS shares, any growth in value from an investment is 100% tax-free. Which is worth noting because small, early-stage companies have the potential to grow significantly.
To qualify for this relief, income tax relief must have already been claimed and the companies must remain EIS qualifying for at least three years.
As mentioned, EIS investments involve buying shares in small, early-stage companies, so the risk of these companies dropping in value or falling entirely are higher than most investments. Where things do not go to plan, it is possible to offset any loss, less the income tax received, against your income tax liability or a capital gains tax liability.
This relief offers protection in the future should companies held within the EIS fail.
Whilst EIS investments offer attractive tax reliefs, these are classed as high risk (and potentially speculative risk) investments and investing in small, early-stage, EIS-qualifying companies is unpredictable and suited for investors who are comfortable with the high risks associated.
As always, as part of our ongoing service we consider the suitability of these investments to meet our client’s needs. It is important to stress that these types of investments are not suitable for everyone, and we need to ensure appropriate consideration is made of the associated risks alongside the benefits. However, from the above you can see some of the potential benefits offered by these investments.
Should you wish to receive further information or discuss these or any other specific solutions, please do not hesitate to contact your Financial Planner who will be more than happy to discuss this with you.