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Sam McArthur: “EIS investment holds the triple appeal of supporting the economy, government-backed investments and attractive tax benefits.”
Sam McArthur picks out eight reasons why recent years have seen EISs become increasingly popular with advisers and clients looking for tax-efficient investments
As the tax year draws to an end with annual allowances for pensions and ISAs near exhaustion, you may be wondering which alternative investments can help your clients who want to invest tax-efficiently.
Far more than an alternative investment, however, the government-backed Enterprise Investment Scheme (EIS) remains a highly sought-after way for small UK companies to attract growth capital investment, having raised nearly £1.8bn in the 2016/17 tax year, according to government figures.
Not only does the EIS help companies grow and become more profitable, it provides investors with the opportunity to capitalise on that success. Indeed, with a surge in investment, interest and press coverage, in recent years EISs have become increasingly popular with advisers and their clients – and here are eight reasons why.
EIS investment’s triple appeal
EIS investment holds the triple appeal of supporting the economy, government-backed investments and attractive tax benefits that are usually uncorrelated to mainstream capital markets. They are particularly inviting for people looking to reduce their income tax bills.
And, given the relatively recent caps on annual pension contributions, the scheme can help investors who want to save tax-efficiently for their retirement but can no longer make use of their pension contribution allowance or lifetime pensions allowance.
A portfolio approach
Investors can either invest into an EIS-qualifying company directly or via an EIS fund. An EIS fund will then invest in a portfolio of qualifying companies – delivering tax reliefs once those investments have been made and a company has issued investors with the all-important EIS3 certificate.
This means there is likely to be a period of months until an investor’s money is fully invested and all of the tax reliefs are available. EIS investments must also be held for a minimum of three years in order to validate the tax incentives.
Income tax rebate
As well as the feel-good factor that comes with helping small and medium-size enterprises (SMEs) in the UK to grow, a key driver of investment into EIS is the 30% income tax rebate. This income tax relief also provides flexibility as it can be used to offset income tax already paid or payable in either the current or previous tax year on an investment of up to £1m. Furthermore, if investing in ‘knowledge-intensive’ businesses, that annual limit doubles to £2m.
Another popular feature is that capital gains from an EIS investment are free from capital gains tax (CGT) and an EIS investment also allows investors to defer a CGT liability. This means EISs can especially benefit anyone facing a CGT bill after selling a business or an asset, such as an investment property.
Loss relief’s key role
The tax reliefs do not end there, however – loss relief also plays a key part. Indeed, investors can avail themselves of loss relief if any one of the companies in an EIS portfolio exits at a loss.
If that happens, the investor can offset that loss against taxable income in the year the loss occurs, or even carry it back to address income tax liabilities from the previous tax year. Crucially, it is available even if the rest of an EIS fund is in profit and can be taken as a normal capital loss too.
Buying into business relief
In addition to supporting growth via a government-backed scheme, one of the EIS’s most compelling features is its eligibility for business relief. This means, if an EIS investment is held for at least two years including at death, business relief can exempt the investment from inheritance tax (IHT).
And as IHT is usually a particular focus for clients at an age where they may also be drawing down from a pension, the combined income tax and IHT benefits can deliver a highly effective combination. Bear in mind, however, that EISs are not tradable or readily realisable, so investors should be comfortable with a long-term investment horizon.
Long-term growth generation
To support SMEs effectively, EIS investments typically focus on generating long-term growth rather than offering a regular yield. This means that, in addition to attractive tax reliefs, EISs offer investors the opportunity to access exciting, high-growth businesses across a range of sectors that have the added advantage of being mostly uncorrelated with mainstream investments.
Diverse opportunity set
And, as an example of the diverse scope of opportunities available, the Puma Alpha EIS fund has recently invested in a high-performing pub and casual dining group, a professional quality cycling clothing brand that exports to 50 countries, an auto wheel manufacturing business with supply contracts to several leading performance car brands, a budget gym chain and a ‘destination’ garden centre business.
Although an investment into an EIS fund does carry risk, it also offers numerous generous tax reliefs. For investors looking for ways to complement their traditional savings routes while also benefitting from growth, EISs can provide a valuable solution.
Sam McArthur is chief operating officer at Puma Investments