If you invest in young businesses, there are generous tax relief schemes which can reduce the potential risks. One of the best known is the enterprise investment scheme or EIS. How does it work?
Enterprise investment schemes (EIS) explained
Enterprise investment schemes are tax-efficient structures that let investors put money into what are called ‘qualifying’ companies. These are often start-up businesses or younger companies that may have found it hard to raise funding elsewhere. EIS schemes:
1. Are suited to high risk investors. These schemes are only suitable for investors who are comfortable with the high level of risk that comes with investing in these companies. If they do well, you could get a high level of return, but it’s not guaranteed and you should only invest a small amount of your portfolio, even if you’re comfortable with higher risk investments.
SAVVY TIP: Unless you’re truly comfortable making decisions on your own, it’s a good idea to get advice about most areas of investments, but it’s vital if you’re thinking about investing in a company and taking advantage of an EIS.
2. Can reduce your income tax bill. As long as you keep your money invested in the EIS scheme for at least three years, you can reduce your income tax liability by 30% of the amount you’ve invested.
SAVVY TIP: This means that a £10,000 investment would actually cost you £7,000 after income tax relief at 30%. There are other conditions that you have to fulfil — for example, you cannot hold more than a 30% interest in a company, or have a connection with the company or with a subsidiary of it. The maximum you can invest is £1 million (or £2 million for married couples).
3. Can deliver profits free of capital gains tax. EIS investments let you take gains free of capital gains tax after three years.
4. Allow you to defer capital gains tax from investments held outside the EIS. Capital gains tax on gains (which are essentially profits over and above any allowances you may have) you’ve made on non-EIS investments can be deferred as long as you sold the assets less than three years before you made the EIS investment or less than 12 months afterwards.
5. Can be exempt from inheritance tax. If you hold onto the investment for at least two years, your heirs won’t have to pay inheritance tax.
– Give you tax relief against losses. If you sell your EIS investment and make a loss (once you’ve taken account of the income tax relief you’ve received) you can offset this loss against any profit you make when you sell shares or other investments – either in the year you sell your EIS shares or the previous tax year.
Enterprise investment schemes and risk
Investing in enterprise investment schemes is not for the faint hearted. Many smaller and younger companies fail and this higher level of risk explains why the tax savings are so generous.
SAVVY TIP: Not all fail, though! Some companies that have used the EIS structure to raise money that you may be familiar with include Innocent (the fresh fruit drinks maker), Carluccios restaurants and Plumb Baby, makers of organic baby food.
You can reduce the risk of EIS investing by investing your money in more than one company through an EIS fund. EIS fund managers are likely to ask several questions before they invest in new or young companies, such as:
Q1. Has the management team done this before? Experience is good and failure may be part of that picture, but you don’t want to put your money into a company where the management team has had nothing but failures.
Q2. Are the companies start ups? Start ups are invariably riskier than businesses that have been trading for some time.
Q3. Do those running the business have their own money riding on this venture or do they expect investors to invest on their own?
Q4. Are there experienced advisers on board already?
Q5. Who else is investing? Are any of the other investors experienced?
Q6. Is there a sound business idea? It’s not just the idea that’s important but the market has to be one that makes the business commercially viable.
SAVVY TIP: If you’re interested in finding out more about enterprise investment schemes, there’s lots of information on the EIS Association website. I’ve said it before, but it bears repeating – do make sure you take expert independent advice as the level of risk varies and some can be very high risk investments.
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