The November 2017 Budget announced several changes to the Enterprise Investment Scheme (EIS). EIS is designed to help smaller trading companies to raise finance by offering a range of tax reliefs to investors.
The changes are part of the government’s Patient Capital Review of support for small businesses.
Below we look at the main changes and how they could affect private investors.
The main changes are:
EIS allowance doubled for investors
Investors using the Enterprise Investment Scheme as a tax-efficient wrapper were rewarded with a surprise doubling of the investment limit.
EIS has been around since the 1990s and is designed to encourage investment in small, unquoted companies. Often these companies struggle to attract the funding they need to grow, so the government incentivises investment by offering tax relief. EIS investors receive 30 per cent income tax relief and they do not need to pay capital gains tax (CGT) on any investment returns, as long as the investment is held for three years. Additionally, losses can be claimed against income tax meaning the highest rate tax payers can limit exposure to 38.5 per cent of monies invested.
The maximum annual amount that an individual can currently invest through the EIS is £1 million. The Chancellor announced that the current limit will be doubled to £2 million where any amount above £1m is invested in knowledge-intensive companies.
The Treasury expects the change to unlock £7 billion of new investment in early-stage enterprises.
Better access to growth capital for knowledge-intensive companies
Knowledge-intensive companies like university spinouts, life science and technology companies will have better access to growth capital. Under the new proposals qualifying growth businesses will be able to raise a maximum of £10 million, up from £5 million.
The age rule for eligible companies will be amended to allow EIS investment up to 10 years after the end of the accounting period in which turnover exceeds £200,000.
This will provide EIS qualifying companies with greater flexibility as they will be able to choose whether to use the current test of the date of first commercial sale or the point at which turnover reached £200,000 to determine when the ten year period has begun.
This could make follow-on investment in successful companies easier and potentially result in greater returns for investors.
Focus on entrepreneurial companies
Only entrepreneurial businesses will be able to qualify for EIS going forward.
Over the last few years some companies have been trying to use EIS to enable investors to invest in low risk, asset backed companies and still take advantage of the generous tax breaks. The government is now cracking down on any investors claiming EIS tax breaks on low-risk investments rather than the innovative high-risk companies the scheme is designed to help.
From 2018 HMRC will implement a ‘capital preservation purpose test’, aiming to exclude investments undertaken for capital preservation. Going forward, all EIS qualifying companies must have the capacity to grow quickly and not simply be an asset backed tax shelter
For SEIS, the Treasury seems satisfied that it works well at incentivising investment into the earliest stage companies of under two years old. There are higher tax breaks to SEIS investors to reflect the higher risk of investment.
What does all this mean for investors?
Investors looking to take advantage of the generous tax breaks on offer through the EIS will need to make sure the investee companies truly embrace the essence of EIS.
A consultation paper published by the Treasury in August 2017, Financing Growth in Innovative Firms, identified a £4bn funding gap between US and British firms and looked at ways to ensure start-ups were receiving access to the financing they needed. At the time, the government expressed concern that too many EIS and VCT investments were focused on “capital preservation”.
The government has been quite clever in redirecting where investment should go by raising the limits on high-risk EISs. About 4,000 investors a year are expected to benefit from the increased investment limit, according to Treasury estimates.
Mark Brownridge, director general of the EIS Association said “We see this as a sensible way forward for ensuring that EIS investment is only directed at genuine, entrepreneurial, growth businesses,’
‘Elsewhere, we understand that HMRC will commit to a 15 day turn around for companies applying for EIS eligibility Advance Assurance by spring next year, which should result in an end to the long delays and backlogs in the system and pave the way for more companies to receive EIS investment.’
Investors will need to be careful going forward that any EIS investment satisfies the new ‘risk to capital’ condition and not been structured to provide a low risk return for investors. This has two parts: whether the company has objectives to grow and develop over the long term; and whether there is a significant risk that there could be a loss of capital to the investor of an amount greater than the net return.
Here at CSS Partners, we welcome the Treasury’s intention to focus the industry on innovation and growth. EIS investments have created thousands of jobs in the UK and helped to transform small, innovative companies into household names. We believe all EIS investments promoted by CSS Partners since 2001, fall within the new rules and have embraced the spirit in which the government has incentivised investment by offering significant tax breaks.
To find out more on the Enterprise Investment Scheme see EIS
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Any views or opinions expressed in this blog are those of the author alone, except where specifically stated that they are the views of CSS Partners LLP.