Enterprise Investment Schemes (EIS’)
There are several different types of EIS and the tax and investment rules for each type of EIS can vary:
Single Company EIS
If you are going to invest in a small business, you may be able to do so through a Single Company EIS. However, as the concentration is in just one company, the lack of diversification brings additional risk to this approach. There is often no opportunity to sell your shares unless the company is sold or it has enough cash reserves to buy back its shares.
EIS Portfolio
Otherwise known as Unapproved EIS Funds, an EIS Portfolio is generally a professionally managed service which invests on your behalf in a number of underlying EIS investments; the norm is at least ten different companies. Tax relief is available from the date the EIS invests in each company and not when you place your money with the fund manager.
Knowledge Intensive Funds (KIFs)
A replacement for the old ‘approved funds’, a KIF is a fund which invests in Knowledge Intensive Companies. Such companies carry out research, development or innovation at the time they are issuing shares. For HMRC approval though, other conditions must be met:
- Of the fund’s capital, at least 80% must be invested in companies that were knowledge intensive at the time of the share issue; and
- The fund must have invested 50% of its capital within 12 months of the date the fund closed and 90% within 24 months.
Whilst tax regulations refer to Enterprise Investment Schemes as ‘Funds’, they should not be confused with mutual funds or collective investment schemes. An investor in an EIS fund will be the owner of shares in the underlying companies, rather than owning shares or units in any fund.
HMRC KIFs are only approved in relation to their tax reliefs and not in relation to the performance of the fund. Also, unlike Venture Capital Trusts (VCTs), EISs are not quoted on the stock exchange.
Minimum monthly contributions are normally £25-£50 and minimum lump sums £500-£1,000. There is no maximum limit although the maximum investment that can qualify for income tax relief is £1m per tax year. Investors can invest up to £2m as long as anything over £1m of this is invested in knowledge intensive companies.
Generally, there is little or no liquidity in EIS companies or funds. EIS’ are investments in individual unquoted companies and EIS funds can consist of as few as four unquoted companies. Shareholders are normally locked into investments with no means to dispose of the shares until the company directors or fund managers achieve an exit, such as quoted market flotation, trade sale or share buy-back.
Not all companies/funds offer the ‘share buy-back’ facility which may be a factor worth considering for the prospective investor. It would be prudent to view these investments as medium- to long-term.
Guaranteed exits are not permitted under EIS rules.
There are several conditions to be met for gaining EIS relief. Tax relief for qualifying individuals who subscribe for eligible shares in a qualifying company, where a qualifying individual is someone not connected with the company when subscribing, although in some circumstances they can subsequently become a paid director of the company. Non-UK residents are eligible but can only claim tax relief against his or her liability to UK income tax.
Eligible shares are new ordinary shares and no income tax relief is given if more than 30% of the capital is acquired. Qualifying companies must be unlisted when shares are issued and must have no arrangements at that time to become a listed company. It must have a permanent establishment in the UK, including companies whose shares are listed on the AIM, but with a requirement that gross assets cannot exceed £15m before the share issue and £16m after the share issue. The company must have fewer than 250 full-time employees (or their equivalents) at the time the shares are issued.
Most trades qualify but the company may not, if more than 20% of the trade includes activities such as land and property development, hotels, nursing homes, farming, forestry and companies which are mostly involved in financial services or related undertakings.
To gain freedom from income tax relief claw back, investors must hold shares for at least three years from the later of the date of issue, or the date the qualifying trade begins.
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