How the Enterprise Investment Scheme (EIS) helps with tax relief
The Enterprise Investment Scheme (EIS) can really help small unquoted companies because it allows them to raise capital by encouraging investment through a series of income tax and capital gains tax reliefs.
The scheme is open to all companies and investors who meet the qualifying criteria, as set out here.
In the year the investment is made you can claim income tax relief of 30% of the total investment up to a maximum of £300,000. The total investment for the year ending 5 April 2014 is £1m.
It is possible to claim the income tax relief against the year preceding the investment. If you have invested through an approved investment fund you will normally get the relief in the year the fund closes.
In order to claim the income tax relief the investment must be held for a minimum of three years. If it is sold before that time the tax relief will be clawed back.
Capital Gains Tax
You can defer any capital gains tax due on previous gains by investing those profits into an EIS. Unlike with income tax relief, there is no cap on the amount of capital gains tax that can be deferred.
If you want to defer any capital gains tax the investment must be held for at least three years. After this time capital gains tax will be liable on the total investment unless it is reinvested in another EIS. Any profits gained from the EIS are not liable to capital gains tax.
The window for taking advantage of the capital gains tax relief is up to one year before and three years after the date of investment.
There is no minimum length of time for the investment to be held to claim the capital gains tax deferred relief.
When the investment is realised, any loss can be offset against either any capital gains or any income tax due in the year it is realised. If you are a higher or additional rate taxpayer it may be more beneficial for you to claim it against your income tax liability for the year.
In August 2010, John sells a painting for £600,000, making a gain of £450,000. He decides to invest the whole £450,000 into an EIS in November 2011.
Since John made a gain in the year ending 5 April 2011, he has to pay capital gains tax on this (of £123,172*).
*The calculation is as follows:
Total gain: £450,000
Less Annual Exempt Amount for 2010/11: £10,100 = £439,900
CGT Chargeable at 28% = £439,900 * 0.28 = £123,172
His income tax liability for the year ending 5 April 2012 is £150,000. Since the investment was made in the same tax year, he is eligible for tax relief of 30% of the investment amount (£45,000), so his total tax liability for that year is £105,000.
In addition, he can claim back the capital gains (of £123,172) paid in the previous year, as the gain occurred within the time-frame (1 year in the past).
In November 2014, John decides to sell the investment. The deferred capital gains tax is due on the initial £450,000. However, instead of paying £123,172, he now pays capital gains calculated at that year’s rates – Assuming he remains a higher rate taxpayer, this will be 28%, but the annual exempt amount for that year is £11,000, so the total capital gains tax is £122,920.
At this point, the investment is valued at £700,000. Note that there is no tax to pay on the EIS gain (£250,000). If another EIS investment had been made, then this capital gains tax would again be deferred, and he would be able to claim income tax relief again (provided this EIS investment is held for a minimum of 3 years).
Case Study 2
Instead of £700,000, John’s EIS investment is valued at £350,000 (a loss of £100,000) when he sells it. In this scenario, the capital gains loss of £100,000 can be claimed against either the ‘crystallised’ gain (the original £450,000), so would only have to pay capital gains tax on £350,000 (A reduction from £122,920 to £94,920), or it can be claimed against his taxable income for the year. If John is still an additional rate taxpayer (his total tax liability is £150,000 again) then this would be reduced by £50,000, being income tax relief at 50% of the capital loss.
Calculators ready….which is better?
Claiming against Capital Gains Tax: £150,000 (Income tax) + £94,920 (Capital Gains Tax)
= Total liability of £244,920
Claiming against Income Tax: £100,000 (Income tax) + £122,920 (CGT)
= Total liability of £222,920
Clearly getting 50% income tax relief saves you more money than 28% capital gains tax relief.
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