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The Finance Act 2018, enacted on 15 March, has made notable changes to the Enterprise Investment Scheme (EIS) which offers tax breaks of 30% to investors willing to buy into high-risk, early-stage businesses. This came about because the Chancellor was concerned that EIS was increasingly being used as a “capital preservation” vehicle rather than a route to fund high-growth, high-risk companies. Many asset-backed funds, therefore, no longer comply. According to the FT, the EIS Association (EISA) reported that roughly £900m was invested into EIS funds in 2016-17, around half of which went into asset-backed schemes. These schemes are now closed to new investments.
These changes to the scheme have made some financial advisers question the benefits of EIS. Are they still a relevant and appropriate investment vehicle for their clients going forward, despite the changes?
The Enterprise Investment Scheme (EIS) was launched by the UK Government in 1994 to stimulate entrepreneurship and encourage private investors to invest for the long-term in unlisted, early-stage businesses. Specifically designed to boost the flow of growth capital in sectors such as technology, engineering and business services, the scheme became popular with investors “in the know” and has exhibited steady growth since its inception. Indeed, EIS has directly stimulated £16.2 bn of investment into UK businesses and supported more than 26,000 companies, according to the Office of National Statistics (ONS).
The rules around EIS have been tweaked frequently by Government over the years. In 2011/2012, increases were made to the size of investment a company could apply for and also the amount an individual investor could allocate was raised from £250k to £1m. The removal of renewables as an eligible asset was introduced in 2013/2014. The latest tweak involves the removal of asset-backed investments, because the Government was concerned that some of the underlying investments were not all capital growth companies. As a result, funds now face a “risk-to-capital condition” which means they are required to evidence “capital at risk” to HMRC.
Benefits of EIS
Regardless of these changes to the underlying investments, however, the validity of the structure of EIS still remains intact. The scheme continues to offer generous tax reliefs designed to mitigate the risks associated with investing in unlisted, early stage companies, including:
- Income Tax Relief: Investing in an EIS company can give you up to 30% income tax relief. To incentivise investment for the long-term, shares must be held for at least three years. Budget changes to EIS mean that an investor can invest up to £2 million per annum in EIS-qualifying companies and receive up to £600,000 of income tax relief;
- Free from Capital Gains Tax (CGT): All profits on investments in EIS-qualifying companies are completely exempt from Capital Gains Tax, providing the shares are held for a minimum of three years. Generally, the majority of investments are liable for Capital Gains Tax, but with EIS, this tax free allowance can be applied to other investments. Another less publicised benefit of EIS investment is that you are also entitled to defer CGT, regardless of the source of the capital gain;
- Unshackled from Inheritance Tax: EIS investments are exempt from inheritance tax. As with the other tax advantages, the investment needs to be held for a minimum time period, in this case two years;
- Established and Democratic: Another compelling reason to consider EIS is its proven track record. Now in its 24th year, the established initiative has a proven track record and remains open to all and completely democratic, regardless of how much money you have to invest.
The future of EIS
The market is now in a situation where advisers have to discontinue their historic practice of repeatedly allocating to just a few large fund managers who focused primarily on asset-backed investments, while ignoring the rest of the market. The fact of the matter is there are, nevertheless, many long-established and credible fund managers who have been solely focusing on pure capital growth investments for many years now. The demand for EIS from a financial planning perspective still remains extremely high and financial advisers will need to uncover these fund managers (if they are not already allocating to them) and gain an understanding of them quickly and efficiently.
Meet demand efficiently
Because advisers’ activity is expected to continue to grow in this space due to ongoing underlying client demand, discoverability and awareness of market participants will become ever-more crucial. Allocating using CoInvestor’s platform makes this process much easier and quicker than traditional methods. The changes to EIS do not mean that this attractive scheme needs to be shunned altogether. To the contrary, value still remains, it just needs to be efficiently found.