Investing in small growth businesses?

The Enterprise Investment Scheme (EIS) aims to encourage investment in small, growing businesses. EIS investments can be made into companies or funds which qualify and have valuable tax advantages as a result.

The main reason why such incentives are provided is based on the contribution small businesses make to the UK economy, in the form of job creation and tax generation.

For experienced investors, the main appeal is the chance to invest in the newest and most exciting businesses with the added benefit of tax relief:

• up to 30% income tax relief, either against this year’s tax bill, or last year’s via a carry back facility
• ability to defer capital gains made elsewhere, by investing these in an EIS
• tax-free growth, no Capital Gains Tax liability if your investment does well
• loss relief, if an EIS investment does not work out, it is possible to offset losses against income or capital gains tax
• inheritance tax free, provided the EIS is held for at least two years and you still hold it on your death.

The tax advantages are significant, but investors should make their decision to invest based on the merits of the investment itself, not the tax benefits. Tax rules can change and tax benefits depend on individual circumstances. To retain the tax benefits of an EIS investment they need to be held for at least three years and the investment must remain qualifying. 

Risks of EIS investment

Relative to investing in large businesses, investing in small businesses is more risky. This is because small businesses are prone to failure and shares in such businesses can prove difficult to sell. It's because of these reasons that the Government provides tax incentives when investing in EISs. Such incentives can in part, mitigate any downside associated with failure, but build on the upside of success.

Given that investors should have received 30% initial income tax relief, the value of the investment has to fall by 30% before investors suffer a net loss. Investors can also write off losses against either income or capital gains tax. This means in the worst-case scenario, the investment fails with no recoverable assets; the maximum effective loss for a 45% taxpayer could be as little as 38.5%.

Who might consider an EIS?

EIS are for wealthier and sophisticated investors who do not expect to access the amount invested, or receive an income from it. They also need to be able to tie up their capital for the longer term. Additionally they must be able to accept the possibility of losing some or the entire sum invested.

Accordingly, EIS investors might include those:

• with a significant income tax, or capital gains tax liability
• who have received their pension tax-free cash lump sum and wish to invest it and wish to obtain tax relief
• who are affected by the Pension Annual or Lifetime Allowance.

If you would like to find out more about EISs, or want to discuss the issues raised, please contact your Dentons Wealth Independent Financial Adviser.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.