An introduction to the Enterprise Investment Scheme (EIS)
Most English entrepreneurs and more likely the investors have heard of the EIS - a scheme aimed at encouraging investments into trading SMEs that are considered high-risk. For those of us who have not had the chance to learn about this, we hope this post will add value.
The EIS was introduced as early as 1994 to succeed the Business Expansion Scheme (BES).
The main intention of the scheme - an alternate finance option for small businesses. Remember that in 1994, venture capital was probably still in their nascent stages in this part of the world.
Individuals who have invested and have met all eligibility requirements can claim a tax relief of 30% against his income tax liability for the year. The relief is on actual amount paid up for shares and is limited to a maximum of 1 million (UK Pounds). So the maximum relief one can enjoy is capped at 300,000 pounds. (approx USD 213,000).
Capital Gains exemption
The investments made under the EIS scheme will be free from taxes on capital gains when disposed off for a profit after the holding period is completed. The usual rates of capital gains tax in the UK is either 18% or 28% depending on the income bracket an individual falls into. For the specific case of disposal of shares, other reliefs apply based on what they are used for.
1. The Holding period - Any investment made by investors under EIS has to be held for a minimum period of 3 years. The rules applicable at the time of investment continues to remain valid for the minimum holding period
2. Paid up share capital - The gov.uk webpage on EIS gives a clear explanation of this factor. Money committed will not get you an EIS approval. Money paid does. Possibly more relevant for start-ups, the company should have a bank account and the money on shares allotted has to be paid into the account for the contributions to be considered as eligible for tax deductions under the scheme. As per the mentioned webpage, this is one of the most common reasons for investments failing to qualify for the deductions.
3. Full-risk - The shares committed to and paid up by the investors should not have any preferential rights. So it's open to all the risks associated with running the business. Preferential rights include but not limited to cumulative dividends, asset-protection or shares in lieu of loans or other arrangements.
4. Commercial purpose - The investment should be in the spirit of running the business commercially. The scheme is not to be used as a tax saving mechanism by parties so that amounts parked in eligible companies are incentivized.
A normal tax payer might think whether he can take part in the scheme. A lot of us tend to contribute money to friends or family who are starting their business. Yes this is possible as long as the company that's receiving the investment is EIS approved. There are professional companies that have formed investment vehicles called EIS funds - some even approved by the HMRC. They help individuals invest in a portfolio of companies that are under the scheme and spread the risk. Given that the investments are being made into early stage ventures, it's a safer way for individuals not used to such activities.
The downside - While professional EIS fund managers are a great way to manage your investment monies, the fees charged for the service tend to be high.
We have touched upon a few basic details regarding the EIS here - there is more details available in the gov.uk website. From how to get a company EIS approved to details regarding how to liquidate the stake, information is available online. A good read of the same or reaching out to professionals who deal with such is a great idea to evaluate an opportunity at hand.