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In the latest in his series of tax-planning articles for Professional Adviser, Jack Rose (Head of Tax Products at LGBR Capital) offers an introduction to the Enterprise Investment Scheme, looking at how it works, how to access it and the types of client it could suit.

The Enterprise Investment Scheme (EIS) is a government initiative launched in 1994, designed to encourage investment by individuals into early-stage companies as an alternative source of funding to more traditional sources of capital.

To balance the increased risk of investing in smaller companies, there are some attractive tax breaks offered by the government. Although more than 20 years old, the EIS heritage actually stretches back to 1981 through its original guise of the Business Start-up Scheme (‘BSUS’) and then latterly the Business Expansion Scheme (‘BES’) in 1983, before finally becoming as we know it as today in 1994.

Since then, more than 24,500 companies have received investment through the scheme and more than £14bn has been raised. Last year alone, according to the April 2016 HMRC & National Statistics Report, more than £1.6bn was raised under the EIS scheme.

Unlisted or AIM-listed companies can apply to HMRC to become “EIS qualifying”, which requires meeting several investment criteria, including:
* They must undertake a “qualifying trade” – certain trades, such as dealing in securities/financial instruments and forestry and farming are excluded;
* They must have fewer than 250 employees, unless it is a ‘knowledge intensive’ business;
* The company must not be controlled by another company;
* The company’s gross assets must not exceed £15m before the investment, or £16m post investment; and
* An investee company cannot be older than seven years, unless it is a knowledge intensive business.

It is also important to note that, despite often being referred to as ‘EIS funds’, they are not collective investment schemes. An investor in an EIS will be the owner of shares in its underlying companies, rather than owning shares or units in a fund.

Given the investment criteria above, EIS companies are smaller and less liquid than larger, listed investments. To compensate investors for the extra risk taken, EIS offer a number of generous tax incentives, including:
* 30% upfront income tax relief (subject to £1m investment in any tax year and provided shares are held for a minimum of three years);
* 100% inheritance tax relief after two years;
* 100% capital gains deferral for the life of the investment;
* Tax-free growth; and
* Loss relief.

Ways To Access EIS Companies

Investors can invest in single EIS companies or an EIS ‘fund’. The reason for the inverted commas is that, despite the name, an EIS ‘fund’ is structured as a discretionary management service in which a manager with expertise in unquoted companies will use their knowledge to select a portfolio of EIS-qualifying companies.

Within each of these categories there is a multitude of different investment strategies covering multiple sectors:

* Single EIS company: Investment is made directly into just one EIS company, meaning investors take on the risks/rewards of the company, which lacks diversification. There is, however, often more clarity on the company’s investment objectives and the timings on the EIS tax certificates.

* EIS portfolio service: The asset manager invests into a basket of what they believe to be robust EIS-qualifying companies, usually under a discretionary management agreement with the investor. They are usually ‘evergreen’ – meaning they are always open for investment. Each client portfolio can be slightly different, depending on the timing of investment, and is usually made up of between five and 10 underlying companies. Tax relief on cash is available only from the date of investment into each underlying EIS company, however, not the date of the initial investment into the service.

* EIS funds: These vary in structure – for instance they can be under a discretionary management agreement or structured as an alternative investment fund. The asset manager invests into a basket of investee companies that fit the fund’s investment mandate. The fund will target a specific amount of capital and will close once it reaches capacity. The number of investments will vary within the fund, depending on the investment criteria. As with the portfolio service, tax relief on the investment is available only from the date of investment into each underlying EIS company.

* Approved EIS funds: These are like the EIS funds mentioned above – with the addition that the fund has received advanced assurance from HMRC that it will qualify for EIS status before an investor’s investments are made. The manager must invest 90% of the money within 12 months of raising capital to qualify but it does ensure EIS tax relief will be on the full amount at the initial date of investment into the approved fund.

For What Types Of Client Are EIS Suitable?

First, while it is important to consider the tax-planning implications for a client, to use the ever popular tax cliché – ‘the tax tail should not wag the investment dog’. EIS should be considered on their investment merits rather than simply as a way of accessing tax reliefs. Given their focus on smaller, less liquid companies and therefore their increased risk, EIS will not be suitable for every client.

It is also important to mention EIS legislation has been through a period of transition and change over the last year or two, which has altered the landscape considerably. The removal of energy-generating assets, such as solar, and the seven year rule have restricted and tightened what investment managers are able to invest in. This has affected managers’ deal flow and, correspondingly, the products available in the market for investors.

For financial advisers looking to recommend EIS investments, it is important to research both the specific strategy and the wider market thoroughly. There are a number of independent sources such as The Tax Efficient Review, The Tax Shelter Report and MiCap, which provide a lot of useful research and information in this regard.

The 30% upfront tax relief makes EIS attractive for clients looking to offset a large income tax liability. The maximum that can be claimed is £300,000 in any one tax year.

For those who have made a capital gain that is taxable, this can be deferred by investing the gain in an EIS. This will be deferred for the duration of the EIS investment. The capital gain liability can be from three years prior, or one year post the EIS investment. It should, however, be noted this is the date from investment into qualifying EIS companies – something to watch for when using an EIS Service.

Since EIS also qualifies for 100% inheritance tax exemption after two years, it can also play a role in clients’ estate planning. If an investor holds the EIS investment at the time of death, the deferred capital gains liability is also removed along with the investment being zero-rated for inheritance tax.

Jack Rose is head of tax products at LGBR Capital

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