Last week we looked at the Enterprise Investment Scheme (EIS) and Capital Gains Tax, explaining the CGT reliefs and incentives available to investors into the scheme.
With investors able to see benefits in a variety of taxes, this week I’m explaining how investment into EIS-eligible opportunities can affect and mitigate your income tax liabilities.
What is income tax?
Before we jump into the tax reliefs and incentives, it’s worthwhile just reiterating what income tax is. Most will be aware it’s the taxation we pay to the HMRC through either PAYE (pay as you earn), which is deducted at source by your employer from your salary, or is accounted for annually in a personal tax return.
However, income tax isn’t exclusively paid on the salary you receive from an employer, but can also be due on:
- some state benefits
- most pensions, including state pensions, company and personal pensions, and retirement annuities
- rental income
- some job benefits and perks
- income from a trust
With everyone having a personal allowance of £11,500 (as of the 2017/18 financial year), the three current rates of income tax are basic rate (£11,501 to £45,000, charged at 20%), higher rate (£45,001 to £150,000, charged at 40%) and additional rate (over £150,000, charged at 45%).
As such, being able to realise tax reliefs in any form for most can be extremely beneficial. And if they come as a result of an investment into a company that you’re truly behind, all the better.
So what EIS income tax reliefs are available?
There are two clear ways in which an investment into an EIS-eligible opportunity can reduce income tax liabilities: through direct income tax relief and loss relief.
Income Tax Relief
For an investor into the EIS, income tax relief of up to 30% can be claimed on investments. Generally speaking this is up to £1,000,000 in one tax year and with a maximum tax reduction in any one year of £300,000, provided you have sufficient income tax liability to claim the relief against.
This allowance was doubled to £2,000,000 from £1,000,000 in the Autumn Budget last year for ‘knowledge intensive businesses’; those businesses that are aiming to have their activities focused on Intellectual Property they own within 10 years.
In practice, your investment can be reduced immediately by 30%, claiming tax relief on the income tax you have paid. For example, if you buy shares in an EIS eligible opportunities for £20,000, and you have a £10,000 income tax bill to pay, you could reduce this by £6,000 (30% of £20,000), providing you with a reduced £4,000 income tax liability.
The main remits for this relief are that you must have paid sufficient income tax agains which to claim tax relief, and you must hold the shares for a minimum of three years from the date of issue or commencement of trading, whichever is the latest. Should you claim the tax relief at the point of investment, but sell the shares within the three years, the obligation is there to repay the relief in full.
Interestingly, the income tax relief can be claimed in the tax year within which the investment has taken place, but it can be carried back to the previous tax year. Consequently, if you find yourself with a large income tax liability at the end of the 2017/2018 financial year, an investment made in 2018/2019 could be deferred and retrospectively claimed.
The loss relief available through EIS investments is one which can be considered as being bittersweet. One would hope that the company you purchase shares in will go on to be a huge success and produce a brilliant return on your investment.
However, should the company dissolve and the shares no longer hold any value, you can claim loss relief on your income tax liability and see a potential benefit in this way.
Loss relief on income tax is calculated by multiplying the net loss by the rate at which an investor pays income tax.
By way of an example, Fred buys £20,000 of shares in Company A. He claims 30% income tax relief up front and consequently reduces the ‘net cost’ of the investment to £14,000.
Four years after the shares were purchased, Company A dissolved and the shares became worthless. Being a higher rate taxpayer, Fred pays income tax at 40%, and consequently is able to claim loss relief on his tax liability of £14,000 at 40%, a total of £5,600.
Coupled with his £6,000 income tax relief, this bring’s Fred loss to £11,400, and not his full £20,000 investment amount.
Loss relief is in situ as investing in private unlisted companies is a high risk / high return investment strategy, and share values can decrease as well as increase. As long as you’ve held the shares for three years, then an allowable loss may arise. This loss can be applied in the current tax year, or indeed carried forward and set against future income tax liabilities - or importantly, against capital gains tax liabilities (but not both).
A point to note on dividend income tax
EIS investments are not exempt from tax on dividend payments. However, it’s generally expected that in an early stage business where any profit or surplus working capital is realised, it will be reinvested into the company to further fuel their growth and promote the best possible exit value for the founders and investors.
Investing into the EIS and benefitting from income tax reliefs
By investing into EIS-eligible opportunities, you’re supporting the next generation of British businesses. You can be part of the driving force behind the company and follow it as it aims to put into place its ambitious growth plans.
You can view our current investment opportunities here, but before making any investment, you should always take professional advice. We’ve highlighted the income tax reliefs available for investors into the EIS in this piece, but they are all dependent on personal circumstance, so please do seek professional advice to ensure any investment - and the secondary benefits of doing so - are best for your needs.