In last month’s Tax Insider, Daniel discussed how Venture Capital Trusts (VCTs) are a tax efficient way to invest in small businesses through a managed fund. This month Daniel moves onto the final Tax Shelter – Enterprise Investment Schemes, also known as EIS.
What is an EIS?
An EIS is a tax shelter that people have been using for quite a while. It provides some generous tax relief for people who invest in qualifying shares in a trading company.
There are certain types of activities that are excluded for qualifying EIS Companies. The sort of activities that are excluded for EIS Companies are banking, financial services and property investments. Many commercial EIS Companies can be risky investments like companies that VCT’S invest in. However, if you take good investment advice there are some managers with good records and some companies that are property asset backed by investing in Children’s Nurseries or Pubs giving a property element to fall back on if the trade does not succeed.
You are able to invest up to £400,000 pounds a year from April 6th this year into an EIS company and more importantly you are able to claim tax relief at 20%.
In practical terms, what this means is that you will get 20% tax back from the government. So let’s say, for example, you invest £100,000 in one of these schemes, then this means that you would get £20,000 of tax relief.
If you invest in EIS shares during the first half of a tax year, they can choose to carry back the relief to the previous tax year. The limit for this is £50,000. So, if you have income in the previous tax year and invest say £80,000 in an EIS Company shares before October 2006, you could use £50,000 against last year’s tax bill and receive up to £10,000 of tax back.
Four More Significant Benefits of EIS
There are four further tax benefits associated with investing in Enterprise Investment Scheme Shares, and these are highlighted below:
Capital gains tax deferral
Firstly, if you invest in EIS shares, you are also able to get up to the £400,000 limit in investment capital gains tax deferral in the same investment. For instance, if you had sold an investment property and made a £100,000 capital gain and you also had income of up to £100,000 in that year, you would get two types of tax relief on your investment. You would not have to pay the capital gains tax because you could defer it by buying the EIS shares and in addition you’d get the £20,000 income tax relief.
So, in effect you can get up to 60% effective tax relief in an EIS. However, this is only up to the £400,000 annual limit. You can therefore defer capital gains tax on up to £400,000 worth of capital gains and if you also have £400,000 of income get 20% back on top of that. This will mean you will avoid paying capital gains tax on your £400,000 gain at up to 40% or £160,000 (depending on your particular tax position) and also get £80,000 of income tax back. A possible total tax saving of £240,000 on an £400,000 investment!
Defer unlimited amount of capital gains tax
There is a further tax relief that is unlimited and that is the ability to defer any capital gains up to an unlimited amount by investing in an EIS company. This does not have to be an EIS Company that qualifies for income tax on investments. You can actually invest in a company you control, as long as it is involved in a qualifying activity. For example, if you have got a computer software company and you have made a £100,000 gain on an investment property and you don’t want to pay tax on the gain, you could issue new shares in that company to yourself for £100,000. You could then invest that money into your own computer software company and pay no capital gains tax at all until you sell those shares in the future.
Now, obviously on an EIS issue of shares you can avoid all capital gains tax on future disposals on the gain on the shares from the time you bought them, but not the deferred gain. So if you sell those shares again you will crystallize or bring into charge the deferred gain on the initial sale of the investment property. So it’s a deferral and not an exemption. That’s very important for people to realize in relation to EIS. There is a way, of course, of turning that deferral into a permanent exemption and that is to hold the shares until death, at which time no deferred gain will crystallize.
Losses can be offset
If you have sold your EIS shares and been unfortunate enough to make a loss, then the loss can be offset any other capital gains you have made or any other income you have received in the same year.
100% Business Property Relief for Inheritance Tax.
If the EIS company is a trading company, (it would have to be to qualify for EIS relief anyway), then after holding those shares for two years you will, under the current law, get 100% business property relief for inheritance tax. Therefore, not only can you effectively get income tax relief up to £400,000 or unlimited capital gains tax relief, but you could also get complete exemption from inheritance tax on all your EIS investments after two years.
This makes EIS Shares well worth considering for a variety of investors with income and capital gains tax bills and an interest in protecting their assets from inheritance tax.
Summary – A Final Word on Tax Shelters
Tax shelters such as Film Partnerships, VCT’s and EIS Shares; although not as exciting as the tax schemes that I mentioned in part one, they do have valuable tax benefits. If used creatively along with good investment advice, you can make genuine and significant tax savings. The advantage with all three tax shelters is that they have all been approved by the government and they are not the type of things that you are going to have to sit worrying at night about. You don’t need to worry whether the taxman will come knocking at you door or whether he will deny you relief etc.
Providing that the people who run the company operate within the detailed tax rules that have been set down as to how these companies should operate, you will be able to sleep in your bed at night! This is because you can be certain that you have secured tax deferral or full tax relief and the Revenue will not come after you!
