What is the Enterprise Investment Scheme?

In 1994, the government introduced the Enterprise Investment Scheme (EIS). In answering the question what is the Enterprise Investment Scheme, the idea is to help small companies raise funds and grow.

If you invest as a private investor in an EIS, you could receive significant tax breaks such as:

• Loss relief on exit
• Capital gains deferral
• Potential for inheritance tax relief
• Tax-free growth
• Up to 30% income tax relief

 

Tax rules can change, and the tax benefits are only applicable if the company maintains its EIS status. To qualify for the EIS, companies normally need to be small and privately owned.

They will typically have gross assets of less than £15 million and less than 250 employees at the time of investment. However, there are now more relaxed rules for knowledge-intensive firms.

Companies that qualify for the Enterprise Investment Scheme

Companies that qualify for the EIS vary widely and span many sectors and industries. Although the rules are specific, a company needs to continue a trade with a view to making a profit.

Some companies including those that deal in land, commodities, or shares are not available for the scheme. Further exclusions have also been added, including companies that have significant asset backing or contractual revenue streams.

The list of exclusions is quite long; however, it still leaves a significant scope for investors.

Investment limits on an Enterprise Investment Scheme

The maximum you can invest in one tax year is £1 million. However, you can invest up to £2 million, provided anything above £1 million is in a knowledge-intensive investment. Furthermore, you can invest more, although you will not qualify for tax relief or tax-free growth on the excess.

What is the enterprise investment scheme - how to invest

There are two ways to invest in an Enterprise Investment Scheme.

• Single company - Investing directly in a single company gives the investor greater control. However, it also carries a greater risk. The success of your investment depends on the company's fortunes. Many EIS-qualifying companies fail.
• Fund Manager - Investing through an EIS fund offers you some diversification. This can be in a particular sector or area. A professional investment manager also does the research and investment decisions for you. This offers peace of mind for many investors. However, some or all the companies could fail, and as such, you could lose your money. With an EIS fund, you have less control over your investment. Furthermore, the fund manager's expertise comes at a price. As such, investing in a managed portfolio tends to be more expensive than investing in a single company.

 

It is also worth noting that EIS investments are normally suitable for experienced investors as they are all high-risk.

When can I claim income tax relief for an Enterprise Investment Scheme?

For tax purposes, the allocation date of your shares will determine the investment date. You can claim income tax relief after the allocation of your shares, and you have received an EIS3 certificate.

This can take about six months before you receive it. The position is different for knowledge-intensive approved funds.

You can claim tax relief for the tax year the fund closes. However, you can only claim when you have received the EIS5 certificate. This may be up to 24 months after the fund closes.

When will the share allocation take place?

Share allocation will typically over the year, though it can take 12 to 18 months from the date you invest. This is because most EIS, meaning you invest over a period of time.

Single-company investments typically have a closing date. This can be on completion of the fundraising target or a set date.

Shares allocation is normally soon after the offer closes. For knowledge-intensive approved EIS funds, the investment date for income tax purposes is the date the fund closes.

Enterprise Investment Scheme carry back facility

EIS investments offer a 'carry back' facility. You can use this facility to spread your EIS shares over more than one tax year.

This gives you the option to offset the tax relief against incoFme tax from the previous year.  You can only do this if you have sufficient EIS allowance in the tax year to which you are carrying back. 

What returns are on offer?

Any EIS returns tend to be in the form of capital growth rather than dividends. Each offer will normally indicate a target return. However, this is only a target, not a guarantee.

Target returns can vary widely, from 1.3 to 10 times the amount invested. Higher targets tend to indicate higher risk.

Charges

Fees for EIS vary widely, so careful attention should be paid to the documentation. Although individual companies may not charge an explicit fee, administration and operating costs may create a charge.

This will be part of the business's operating costs. Managed portfolios will also carry a fee.

A typical initial fee is between 2% and 5%, and an annual fee is about 2%. They may also have a performance-related fee.

How to buy and sell EIS

EISs do not trade on the stock market. As such, you typically invest through a broker. Most EISs are evergreen, so you can invest at any time.

Most individual company investments have an investment target. When this is achieved, the offer closes.

When it comes to selling your investment, it is the manager's duty to have an exit strategy in place. This allows them to return any capital and tax-free growth to the investors.

You will normally be given an exit strategy and timeframe at the outset. This is normally a minimum of four years.

Common strategies include management buy-outs, trade sales, or refinancing. However, there are no guarantees.

EISs are long-term investments. The minimum holding period to retain the income tax relief is three years.

However, you should expect to hold the share for far longer than this.

EIS advance assurance

This is a service offered by HMRC. Companies planning to raise money under EIS can choose to use it.

If a company has received advanced assurance, it means they have received a letter from HMRC. This letter confirms that the proposed share issue would qualify for EIS tax relief.

This is based on information provided by the company. Advance assurance does not guarantee the company will qualify for EIS tax relief.

This can only be confirmed after the company has issued the shares. Irrespective of whether the company has received (or applied for) advance assurance, after it issues the shares, it must submit a compliance statement to HMRC.

At that point, if all the requirements are satisfied, HMRC will confirm the company is authorised to issue EIS certificates.

Risks with EIS investments

Your capital is at risk as it is with all investments. However, because EIS investments are in small companies, the risk tends to be higher than in other investments.

Small companies tend to be more volatile and are more likely to fail. As such, you may lose your investment.

Furthermore, EIS investments are long–term and not suitable for everyone. They are for high-net-worth or sophisticated investors who do not need immediate liquidity.

Who can also withstand a potential total loss of capital. They may also be harder to sell because there is no recognized market for these shares.

Finally, you must hold the investment for at least 3 years to retain all available tax reliefs. The company also must retain its qualifying status.

Otherwise, you may have to pay back the income tax relief you received. Please note that tax and qualifying rules can change.

Summary

In answering the question what is the enterprise investment scheme, EIS investments are essentially for experienced or wealthy investors and offer generous tax incentives.

They could be particularly attractive to investors with a large income tax bill seeking growth opportunities. The EIS allowance is one of the most generous.

EIS could also be appealing to investors with capital gains tax liabilities.