Index
Part 1: Overview of the Enterprise Investment Scheme (EIS) and Capital Gains Tax (CGT)
Part 4: Interaction Between EIS and Other Tax Relief Schemes (SEIS, VCT)
Part 5: Risks and Considerations for Investors Using EIS for CGT Relief
A Hypothetical Real-Life Case Study of Someone in the UK Dealing with EIS and CGT
Overview of the Enterprise Investment Scheme (EIS) and Capital Gains Tax (CGT)
The Enterprise Investment Scheme (EIS) was introduced in the UK in 1994 as a government-backed initiative to encourage investment in smaller, higher-risk companies. It offers significant tax incentives to UK taxpayers, including income tax relief, capital gains tax (CGT) deferral, and, crucially, CGT exemption for gains realised on investments. In the current financial environment, where tax liabilities can be a major deterrent to investing, EIS has emerged as a strategic way for investors to manage their exposure to capital gains while supporting entrepreneurial growth in the UK.
On the other hand, Capital Gains Tax (CGT) is levied on the profits (or gains) made when an asset is sold or disposed of for more than it was purchased. This tax applies to a wide range of assets, including shares, property, and personal possessions. For individuals, CGT rates in the UK vary depending on the type of asset and the taxpayer's income band. For example, the CGT rates for individuals in the basic tax band are 10% for most assets and 18% for residential property, whereas higher-rate taxpayers face CGT at 20% or 28%, respectively. In this context, investors often look for opportunities to defer or eliminate CGT, and EIS provides one such opportunity.
How EIS Works in Relation to CGT
One of the key benefits of the Enterprise Investment Scheme is the ability to claim full exemption from CGT on any profits made from the sale of EIS shares, provided certain conditions are met. This exemption is particularly attractive to higher-rate taxpayers, who would otherwise face CGT at 20% on the sale of shares. The main conditions for claiming CGT exemption on EIS investments include:
The investor must have held the shares for at least three years from the date of investment.
The company in which the investment was made must have maintained its EIS status throughout the holding period.
The investor must have claimed the 30% income tax relief available on the original investment. If the income tax relief is clawed back, the CGT exemption is also lost.
In addition to the exemption, EIS offers a CGT deferral relief, allowing investors to defer tax on gains from other assets by reinvesting the proceeds into an EIS-qualifying company. This deferred tax becomes payable only when the EIS shares are disposed of, transferred, or the company loses its EIS status. However, this deferral can be extended indefinitely if the investor continues to reinvest in EIS-eligible shares.
Encouraging Investment in High-Risk Companies
EIS was specifically designed to stimulate investment in smaller, high-risk companies that might otherwise struggle to attract capital due to their lack of track record or established revenue streams. The government recognised that smaller companies are vital to the UK's economic growth, job creation, and innovation. However, investing in these companies comes with significant risks for investors. By offering generous tax incentives, including the potential to eliminate or defer CGT, the government effectively reduces the financial risk to investors and encourages the flow of capital to these ventures.
CGT Exemption and Deferral: Key Elements
The primary way EIS interacts with CGT is through the exemption from CGT on gains made from the sale of EIS shares. Unlike the normal rules for CGT, which tax the profit made on the disposal of shares, EIS investors who hold their shares for at least three years can sell them without incurring any CGT, provided the company maintains its EIS status and the investor has claimed income tax relief.
For example, if an investor purchased shares in an EIS-qualifying company for £50,000 and sold them five years later for £100,000, they would normally be liable to pay CGT on the £50,000 gain. Under the EIS scheme, this gain is completely exempt from CGT, meaning the investor keeps the full £100,000 without any tax liability.
The CGT deferral relief is equally important. Investors can defer CGT on gains from other assets by reinvesting them into EIS-qualifying shares. This deferred tax does not become payable until the EIS shares are sold or cease to qualify for the scheme. Moreover, if the investor continues to reinvest in EIS-qualifying companies, the CGT can be deferred indefinitely.
How the CGT Deferral Works in Practice
CGT deferral offers flexibility for investors who are looking to manage their overall tax liability strategically. For instance, consider a taxpayer who makes a £100,000 capital gain on the sale of a property. Instead of paying CGT immediately on this gain (which could be 20% for higher-rate taxpayers), they can reinvest the £100,000 into EIS shares and defer the CGT liability. If those shares increase in value and the investor later sells them for £150,000, the deferred CGT is still payable, but the gain on the EIS shares remains exempt from CGT.
Detailed Explanation of CGT Exemptions via EIS
In this section, we will delve deeper into the Capital Gains Tax (CGT) exemptions available through the Enterprise Investment Scheme (EIS). We will explore how investors can benefit from CGT-free growth, the specific conditions that must be met, and provide examples to illustrate how this works in practice. This part aims to provide a thorough understanding of how EIS can serve as a powerful tool to eliminate or reduce capital gains tax liabilities.
How CGT Exemption Works in EIS
The CGT exemption under the EIS allows investors to avoid paying CGT on any capital gains made from the sale of EIS-qualifying shares, provided they meet the following conditions:
The investment must be held for at least three years – The shares purchased through the EIS scheme must be held for a minimum of three years to qualify for CGT exemption.
The investor must have claimed the 30% income tax relief on the initial investment. If the income tax relief is withdrawn or lost, the CGT exemption will no longer apply.
The company must maintain its EIS status during the holding period. If the company ceases to be eligible for EIS status during the three-year holding period, the CGT exemption may be lost.
If these conditions are met, any gains made on the disposal of the EIS shares are completely exempt from CGT. This exemption provides a significant incentive for investors, particularly those in higher income tax brackets who would otherwise be liable to pay CGT at rates of 20% on their investment gains.
Example 1: Basic EIS Investment with CGT Exemption
Let’s look at a simple example of how the CGT exemption works under EIS.
Scenario: Sarah, a higher-rate taxpayer, invests £50,000 in an EIS-qualifying company in January 2021. The company has met all the criteria to qualify for the EIS scheme, and Sarah claims the 30% income tax relief available on her investment. By January 2025, the value of her shares has risen to £100,000, and she decides to sell them.
CGT Without EIS: If Sarah had invested in a regular company and sold her shares for a £50,000 gain, she would be liable to pay CGT at a rate of 20% (the rate for higher-rate taxpayers). This means she would have to pay £10,000 in CGT, leaving her with £90,000 in proceeds.
CGT With EIS: Because Sarah invested through the EIS scheme and met the necessary conditions, her £50,000 gain is completely exempt from CGT. She can sell her shares and keep the full £100,000 without paying any tax on the gain.
This example illustrates the potential for significant tax savings through the EIS, particularly for higher-rate taxpayers who would otherwise face substantial CGT bills.
Example 2: Multiple EIS Investments and CGT Exemption
Now let’s consider a more complex example where an investor makes multiple EIS investments.
Scenario: Tom, a basic-rate taxpayer, invests £30,000 in EIS-qualifying shares in two different companies: £15,000 in Company A and £15,000 in Company B, both in 2022. He holds the shares for the required three-year period. By 2026, the value of his shares in Company A has risen to £25,000, while his shares in Company B have increased to £22,000. Tom decides to sell all his shares.
CGT Without EIS: If Tom had made these investments outside of EIS, he would have made a £10,000 gain on his Company A shares and a £7,000 gain on his Company B shares. Since Tom is a basic-rate taxpayer, his CGT liability would be 10% of the total gain (£17,000), which would amount to £1,700.
CGT With EIS: Under the EIS, Tom’s £17,000 gain is fully exempt from CGT, provided he claimed income tax relief on both investments and the companies maintained their EIS status throughout the holding period. Therefore, Tom keeps the full £47,000 (£25,000 from Company A and £22,000 from Company B) without paying any CGT.
In this case, the CGT exemption allowed Tom to save £1,700, a significant sum for a basic-rate taxpayer. Over time, as the value of EIS shares increases, these savings can become even more substantial.
Loss of CGT Exemption: When EIS Conditions Are Not Met
While the EIS offers significant tax advantages, it is crucial to be aware of the conditions that can lead to the loss of CGT exemption. Investors must meet the following key conditions, and failure to do so could result in the withdrawal of CGT relief.
Holding Period: If the investor sells their shares before the three-year minimum holding period, they will lose the CGT exemption. In this case, any capital gains will be taxed at the usual CGT rates, and the income tax relief claimed on the investment may also be withdrawn.
Loss of EIS Status: If the company ceases to qualify for EIS status during the investor’s holding period (due to, for example, a significant change in its operations or ownership), the investor may lose the CGT exemption. This can also result in the clawback of income tax relief.
Failure to Claim Income Tax Relief: The CGT exemption is only available if the investor has claimed the 30% income tax relief on their initial investment. If they fail to do so, or if the relief is withdrawn, the CGT exemption will not apply.
Example 3: Losing CGT Exemption
Scenario: Emma invests £40,000 in an EIS-qualifying company in 2023. She holds the shares for two years, but due to personal reasons, she decides to sell her shares in 2025 for £60,000, realising a gain of £20,000. However, because Emma sold her shares before the three-year holding period, she loses her CGT exemption and must pay CGT on her £20,000 gain.
CGT Liability: Since Emma is a higher-rate taxpayer, her CGT liability is 20% of the £20,000 gain, which amounts to £4,000. Additionally, Emma may face a clawback of the income tax relief she initially claimed on the £40,000 investment.
This example highlights the importance of adhering to the EIS conditions, particularly the three-year holding period, to ensure that the full tax benefits are available.
Additional Considerations: Impact of Losses on EIS Investments
While EIS can provide excellent tax reliefs, not all investments succeed. In cases where the investment results in a loss, the EIS scheme offers additional tax relief options. If an investor sells their EIS shares at a loss, they can offset the loss against their income tax (instead of capital gains tax), which can provide a more advantageous tax outcome.
Example 4: EIS Investment Loss and Loss Relief
Scenario: John, a higher-rate taxpayer, invests £50,000 in an EIS-qualifying company in 2021. However, by 2024, the company goes bankrupt, and his shares are worth nothing. Normally, John would lose his entire £50,000 investment, but EIS provides an opportunity to claim loss relief.
Income Tax Relief on Loss: John can claim loss relief on the value of his lost investment. The amount of the loss he can claim is reduced by the income tax relief already received. In this case, John claimed 30% income tax relief on the £50,000 investment (£15,000), so his allowable loss is £35,000. John can then offset this £35,000 against his income tax liability, potentially saving him a significant amount in tax.
This example illustrates how EIS provides not only CGT exemption but also other forms of relief that can mitigate the risk of investing in high-risk, early-stage companies.
Planning for Future Gains: Long-Term CGT Strategy with EIS
For investors with substantial capital gains from other assets, the CGT exemption and deferral options provided by EIS make it a compelling part of long-term tax planning. By strategically reinvesting gains into EIS-qualifying shares, investors can significantly reduce or defer their CGT liabilities while also supporting high-growth potential companies.
EIS is particularly valuable for individuals with multiple investments, such as property investors or those who frequently trade in the stock market. By using the EIS scheme, they can shelter gains from taxation and potentially reinvest in further growth opportunities, deferring CGT payments indefinitely if they maintain EIS-qualifying investments.
CGT Deferral through EIS Investments
One of the most powerful features of the Enterprise Investment Scheme (EIS) is the ability to defer Capital Gains Tax (CGT) on gains from other assets when reinvesting those gains into EIS-qualifying shares. This CGT deferral relief can provide investors with flexibility in managing their tax liabilities, allowing them to postpone the payment of CGT until a later date, or even indefinitely if the investor continues to reinvest in EIS shares.
We will now explore how CGT deferral works, the conditions that must be met to take advantage of this benefit, and provide detailed examples to illustrate how it operates in real-world scenarios. We will also discuss the advantages and risks associated with using CGT deferral in your tax planning strategy.
What Is CGT Deferral?
The CGT deferral relief under the EIS allows investors to defer the payment of CGT on a gain made from the disposal of any asset, provided they reinvest the gain into EIS-qualifying shares. This deferred CGT does not become payable until one of the following events occurs:
The EIS shares are sold.
The EIS shares cease to qualify for the scheme.
The investor becomes non-resident for UK tax purposes.
Importantly, there is no maximum limit on the amount of gain that can be deferred, making it a highly attractive option for individuals with large capital gains who wish to reinvest the proceeds. Additionally, investors can claim CGT deferral even if they did not initially claim the 30% income tax relief available under EIS.
Example 1: Deferring CGT with EIS Reinvestment
Let’s consider a simple example of how CGT deferral works in practice.
Scenario: James, a higher-rate taxpayer, sells a rental property in 2024 for £300,000. He originally purchased the property for £150,000, resulting in a capital gain of £150,000. Normally, James would be liable to pay CGT at a rate of 28% (the rate for higher-rate taxpayers on residential property), which would amount to £42,000.
Deferring CGT via EIS: Instead of paying the £42,000 CGT immediately, James chooses to reinvest the £150,000 gain into EIS-qualifying shares. By doing this, he can defer the payment of CGT. The £42,000 CGT will only become payable when James eventually sells the EIS shares or when one of the other events that trigger the end of the deferral occurs.
Result: James has effectively postponed his £42,000 CGT liability by reinvesting his gains into EIS shares, giving him more flexibility and potentially freeing up capital for further investments.
Conditions for CGT Deferral
To qualify for CGT deferral relief, investors must meet specific conditions:
Reinvestment of the Gain: The gain must be reinvested in EIS-qualifying shares within three years before or after the gain is made.
Qualifying Shares: The shares purchased must qualify under the EIS scheme, meaning they must be issued by a company that meets the EIS eligibility criteria.
No Maximum Limit: There is no maximum limit on the amount of gain that can be deferred, allowing investors to defer gains of any size.
Loss of Deferral on Disposal: The deferred CGT will become payable when the EIS shares are sold or if the company ceases to qualify for the EIS scheme.
Example 2: CGT Deferral and Multiple Investments
In some cases, investors may make multiple investments, each eligible for CGT deferral, allowing them to defer gains across several years or assets.
Scenario: Olivia, a property investor, sells two properties in 2024, realising gains of £100,000 on the first property and £200,000 on the second. She decides to reinvest these gains in different EIS-qualifying companies.
First Investment: Olivia reinvests the £100,000 gain from her first property sale into Company A’s EIS shares. This allows her to defer the £28,000 CGT that would otherwise be due (28% on residential property).
Second Investment: She reinvests the £200,000 gain from her second property sale into Company B’s EIS shares, deferring a further £56,000 CGT liability.
Result: By making two separate EIS investments, Olivia has deferred a total of £84,000 in CGT liabilities. This deferred CGT will only become payable when she sells the EIS shares or if Company A or Company B loses its EIS status.
This example demonstrates how CGT deferral can be applied across multiple investments, giving investors more flexibility in managing their tax liabilities over time.
Potential for Indefinite CGT Deferral
One of the most attractive aspects of CGT deferral under EIS is the potential to defer CGT indefinitely. Investors who sell EIS shares and reinvest the proceeds into another EIS-qualifying company can continue to defer the CGT liability for as long as they maintain EIS-eligible investments. This strategy can allow high-net-worth individuals or frequent investors to defer substantial tax liabilities across multiple investments over a long period of time.
Example 3: Rolling Over Gains for Indefinite CGT Deferral
Scenario: Alex, a higher-rate taxpayer, sells shares in a publicly traded company in 2024, realising a £250,000 gain. Instead of paying CGT on this gain, Alex reinvests the £250,000 into EIS-qualifying shares in Company A, deferring the £50,000 CGT liability (20% on shares for higher-rate taxpayers).
Second Reinvestment: After three years, the value of Alex’s EIS shares in Company A has increased to £400,000. Instead of selling and paying CGT on the deferred gain, Alex reinvests the £400,000 into another EIS-qualifying company, Company B.
Result: By continuously reinvesting in EIS-qualifying shares, Alex is able to defer the CGT liability indefinitely, potentially for the rest of their life. The £50,000 CGT liability from the original gain is only triggered when Alex eventually sells the EIS shares and does not reinvest in another EIS-qualifying company.
This strategy can be particularly effective for investors who want to maximise their tax efficiency over the long term.
Claiming CGT Deferral Relief
To claim CGT deferral relief, investors must complete the relevant sections of their Self-Assessment tax return and provide details of the EIS-qualifying shares in which they have reinvested their gains. It is important to keep detailed records of:
The amount of gain deferred.
The date of reinvestment into EIS-qualifying shares.
The companies in which the EIS investments were made.
HMRC may require evidence that the investments meet the EIS eligibility criteria, so it is crucial for investors to retain the appropriate documentation, such as the EIS3 certificate, which is issued by the company after HMRC confirms that the investment qualifies for EIS relief.
Example 4: Claiming CGT Deferral on Property Sale
Scenario: Tom, a higher-rate taxpayer, sells a piece of land in 2023, realising a capital gain of £180,000. He chooses to reinvest this gain into an EIS-qualifying company, Company X, in early 2024.
Completing the Tax Return: Tom must declare the £180,000 capital gain on his Self-Assessment tax return for the 2023/24 tax year but can also claim CGT deferral relief by providing details of his reinvestment into Company X’s shares.
EIS3 Certificate: To support his claim, Tom receives an EIS3 certificate from Company X, which confirms that his investment qualifies for EIS relief.
Result: By reinvesting his £180,000 gain into EIS shares, Tom defers the £36,000 CGT liability (20% on gains from land sales) until the future disposal of his EIS shares. If he continues to reinvest in EIS-qualifying shares, Tom can defer this CGT indefinitely.
Risks and Considerations
While CGT deferral can provide significant tax advantages, it is important to be aware of the potential risks and pitfalls associated with using this relief:
Loss of EIS Status: If the company in which the investment is made ceases to qualify for EIS during the deferral period, the deferred CGT becomes immediately payable. This can happen if the company undergoes significant structural changes or no longer meets the size or trading activity requirements for EIS.
Timing of Reinvestment: To qualify for CGT deferral, the reinvestment into EIS shares must take place within three years before or after the gain is made. Investors who miss this window may lose the opportunity to defer their CGT liability.
Tax Rate Changes: If the CGT rates increase in the future, investors who have deferred their CGT liabilities could end up paying a higher rate of tax when the deferral ends. This is an important consideration for long-term tax planning.
Example 5: Risk of Losing EIS Status
Scenario: Ben invests £200,000 in EIS-qualifying shares in 2023, deferring a £40,000 CGT liability from the sale of a second home. However, in 2026, the company he invested in loses its EIS status due to a merger with a larger firm that no longer qualifies for the scheme.
Result: Ben is required to pay the £40,000 CGT that was previously deferred, even though he has not yet sold his shares. This highlights the risk of losing EIS status and having to pay deferred CGT unexpectedly.
Interaction Between EIS and Other Tax Relief Schemes (SEIS, VCT)
The UK government has introduced several tax-efficient investment schemes designed to encourage individuals to invest in early-stage companies, which are crucial for driving innovation and economic growth. Besides the Enterprise Investment Scheme (EIS), two other popular schemes are the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCT). Each of these schemes offers a range of tax reliefs, including Capital Gains Tax (CGT) relief, but they differ in terms of the types of companies they support, the level of tax incentives, and the rules governing investments.
We will now explore the similarities and differences between these schemes, particularly in relation to their impact on CGT, and provide examples to illustrate how they can be strategically used in combination to optimise tax reliefs for investors.
Overview of EIS, SEIS, and VCT: Key Differences
Each of these three schemes—EIS, SEIS, and VCT—serves a specific purpose within the UK’s tax-efficient investment landscape. They differ in the types of companies they target and the levels of relief they offer, which can affect investors’ decisions based on their risk appetite, the size of their capital gains, and their investment goals.
Enterprise Investment Scheme (EIS):
EIS is aimed at supporting small and medium-sized enterprises (SMEs) that need capital to grow.
It offers up to 30% income tax relief on investments and provides CGT deferral and CGT exemption if the shares are held for at least three years.
The annual investment limit for individuals is £1 million, or £2 million if investing in knowledge-intensive companies.
Seed Enterprise Investment Scheme (SEIS):
SEIS targets even smaller, earlier-stage companies than EIS and offers more generous reliefs to account for the higher risk involved.
Investors can claim 50% income tax relief on investments and benefit from CGT exemption for gains made on SEIS shares held for three years.
Importantly, SEIS also provides CGT reinvestment relief, which allows investors to eliminate CGT on other gains if they reinvest the gains into SEIS shares.
The annual investment limit for individuals is £200,000.
Venture Capital Trusts (VCT):
VCTs differ from EIS and SEIS in that they are publicly traded funds that invest in a portfolio of early-stage companies.
VCTs offer up to 30% income tax relief on investments and provide tax-free dividends to investors. They also offer CGT exemption on the disposal of VCT shares.
However, unlike EIS and SEIS, VCTs do not offer CGT deferral relief, making them less effective for immediate CGT deferral.
CGT Reliefs Under EIS, SEIS, and VCT
Each of these schemes provides investors with ways to reduce or eliminate CGT liabilities, but the rules governing these reliefs vary. Here’s a closer look at how CGT works under each scheme:
EIS: Allows for CGT exemption on gains from the sale of EIS shares if held for at least three years, along with the option to defer CGT on other gains by reinvesting them into EIS shares.
SEIS: Offers CGT exemption on gains from SEIS shares held for three years. Additionally, CGT reinvestment relief allows investors to eliminate CGT on other gains by reinvesting those gains into SEIS shares, up to £200,000 annually.
VCT: Provides CGT exemption on gains from the sale of VCT shares if held for at least five years. However, VCT does not offer any form of CGT deferral for gains realised on other assets.
Example 1: Combining SEIS and EIS for Maximum CGT Relief
Let’s consider a scenario where an investor strategically combines SEIS and EIS to maximise CGT relief.
Scenario: Matthew, a higher-rate taxpayer, sells a stock portfolio in 2024 and realises a £100,000 capital gain. He decides to reinvest this gain into SEIS and EIS-qualifying companies to take advantage of the CGT reliefs offered by both schemes.
SEIS Investment: Matthew reinvests £50,000 of his gain into SEIS shares. Under SEIS rules, 50% of the gain (£25,000) is completely exempt from CGT due to SEIS reinvestment relief.
EIS Investment: Matthew reinvests the remaining £50,000 into EIS shares. This allows him to defer CGT on the remaining £50,000 gain, which will not become payable until he sells the EIS shares or they lose their EIS status.
Result: By combining SEIS and EIS, Matthew has eliminated CGT on £25,000 of his gain and deferred CGT on the remaining £50,000. If he holds both sets of shares for the required period, he may also benefit from complete CGT exemption on any future gains made on the SEIS and EIS shares themselves.
This example demonstrates how investors can leverage both schemes to manage their CGT liabilities more effectively, particularly when dealing with large capital gains.
Example 2: SEIS Reinvestment Relief
SEIS offers a unique opportunity to eliminate CGT on gains made from other assets by reinvesting the proceeds into SEIS shares. This is known as CGT reinvestment relief.
Scenario: Chloe sells a piece of artwork in 2024, realising a £100,000 gain. Without any tax-efficient investment, Chloe would be liable to pay CGT at 20%, resulting in a £20,000 tax bill.
Using SEIS Reinvestment Relief: Chloe reinvests the full £100,000 into SEIS shares. Under SEIS rules, 50% of the reinvested gain (i.e., £50,000) qualifies for CGT reinvestment relief. This means that £50,000 of her gain is completely exempt from CGT, and she will only pay CGT on the remaining £50,000.
Result: By reinvesting her gain into SEIS shares, Chloe has reduced her CGT liability from £20,000 to £10,000, resulting in a £10,000 tax saving. Additionally, any future gains made from the SEIS shares themselves will be exempt from CGT if held for three years.
This example illustrates the specific advantage of SEIS reinvestment relief, which provides immediate CGT savings on gains made from the sale of other assets.
Example 3: CGT Exemption Through VCT
While VCTs do not offer CGT deferral, they do provide CGT exemption on the sale of VCT shares, along with tax-free dividends, which can be highly attractive for income-focused investors.
Scenario: Richard, a higher-rate taxpayer, invests £100,000 into a VCT in 2024. Over the next five years, the VCT pays annual tax-free dividends, and by 2029, Richard sells his VCT shares for £150,000, realising a £50,000 gain.
CGT Exemption: Because VCT shares are exempt from CGT, Richard will pay no CGT on the £50,000 gain. Additionally, the dividends he received during the five years were also tax-free, maximising the tax efficiency of his investment.
This example highlights the key benefit of VCTs for investors who are seeking both capital gains and tax-free income through dividends.
Strategic Use of EIS, SEIS, and VCT
Investors can strategically combine EIS, SEIS, and VCT to achieve a balance between capital growth, tax relief, and income generation. Each scheme offers unique benefits that can be tailored to suit different investment goals. Here are some strategies for maximising tax efficiency:
Start with SEIS: For early-stage investments, investors can take advantage of SEIS’s generous 50% income tax relief and CGT reinvestment relief to immediately reduce their CGT liabilities. Since SEIS targets smaller, higher-risk companies, it offers more substantial tax incentives to compensate for the increased risk.
Move to EIS: After utilising SEIS, investors can reinvest additional capital into EIS shares to benefit from CGT deferral and CGT exemption. EIS also offers 30% income tax relief and supports larger, more established companies compared to SEIS.
Long-Term Income with VCT: For investors seeking long-term tax-free income, VCTs offer tax-free dividends and CGT exemption on the sale of shares after five years. VCTs provide a more diversified approach by investing in a portfolio of companies, reducing individual investment risk.
Example 4: Using EIS, SEIS, and VCT Together
Scenario: Emily, a successful entrepreneur, sells her business in 2024, realising a £1 million capital gain. She wants to reinvest the proceeds while minimising her CGT liability and generating tax-free income in the future.
SEIS Investment: Emily invests £200,000 in SEIS-qualifying companies. This eliminates CGT on £100,000 of her gain through CGT reinvestment relief.
EIS Investment: Emily invests £600,000 into EIS shares, allowing her to defer CGT on that portion of the gain. She also benefits from 30% income tax relief on the investment, reducing her income tax liability by £180,000.
VCT Investment: Emily invests the remaining £200,000 into a VCT, giving her tax-free dividends over the next five years. Any gain on the eventual sale of her VCT shares will be exempt from CGT.
Result: By using all three schemes, Emily has eliminated or deferred CGT on her entire £1 million gain, received significant income tax relief, and secured tax-free dividends from her VCT investment.
Risks and Limitations
While EIS, SEIS, and VCT offer substantial tax benefits, it’s important to be aware of the risks:
Company Risk: SEIS and EIS investments are typically in early-stage companies, which come with a high risk of failure. Investors could lose some or all of their capital.
Holding Period: The tax reliefs are contingent on holding the shares for a minimum period (three years for SEIS and EIS, five years for VCT). Selling early may result in the clawback of tax reliefs.
Documentation: Investors must keep detailed records of their investments, including EIS3 or SEIS3 certificates, to claim the relevant tax reliefs.
Risks and Considerations for Investors Using EIS for CGT Relief
While the Enterprise Investment Scheme (EIS) offers substantial benefits for investors, including Capital Gains Tax (CGT) deferral and exemption, it is essential to understand the potential risks, pitfalls, and limitations that can affect the overall effectiveness of the scheme. Moreover, as of October 2024, there have been some updates to the EIS and CGT regulations that investors need to consider to ensure they remain compliant and optimise their tax strategies.
In this section, we will discuss the key risks and considerations associated with using EIS for CGT relief, the documentation and record-keeping requirements, and the latest updates to the EIS and CGT regulations. Additionally, we will provide practical examples to demonstrate how these factors may impact investors in real-world scenarios.
Key Risks of Using EIS for CGT Relief
While the EIS offers attractive tax reliefs, investors must be aware of several risks that can affect their ability to fully benefit from the scheme. These include:
Loss of EIS Status:
If the company in which an investor has purchased EIS shares loses its EIS-qualifying status during the three-year holding period, the investor will lose the associated tax reliefs, including the CGT exemption and any deferred CGT liabilities.
Triggers for Loss of Status: Companies may lose EIS status if they undergo significant changes, such as being acquired by a larger company or changing their primary business activity to something that no longer qualifies for EIS.
Investors who lose EIS tax reliefs may face immediate CGT liabilities and, in some cases, may need to repay the income tax relief they previously claimed.
Example: Simon invests £100,000 in an EIS-qualifying tech start-up in 2023. Two years later, the company is acquired by a larger corporation and loses its EIS status. As a result, Simon's CGT deferral on a £50,000 gain is revoked, and he must immediately pay the £10,000 CGT that had been deferred (assuming a 20% CGT rate on shares). He also risks losing his 30% income tax relief, which further increases his financial exposure.
Early Disposal of Shares:
To qualify for CGT exemption, investors must hold their EIS shares for at least three years. If the shares are sold, gifted, or transferred before the three-year holding period has elapsed, the CGT exemption will be lost, and deferred CGT liabilities may become payable.
Additionally, the income tax relief on the original investment may also be clawed back.
Example: Jane invests £80,000 in EIS-qualifying shares in 2022. In 2024, she sells her shares for £120,000, realising a £40,000 gain. Because Jane did not hold the shares for the full three-year period, she loses the CGT exemption and must pay CGT on the £40,000 gain. In addition, the £24,000 income tax relief (30% of £80,000) she claimed on the initial investment is also withdrawn.
Performance of the Investee Company:
EIS investments are typically made in small, early-stage companies that are higher-risk and more prone to failure. While the tax reliefs provided by EIS help mitigate some of the financial risks, investors could still lose some or all of their capital if the company fails.
In cases where the company becomes insolvent, the investor can claim loss relief on the amount invested. However, the losses may only be partially recoverable through the relief, and any deferred CGT will still become payable if the company ceases to exist.
Example: Tom invests £50,000 in an EIS-qualifying start-up in 2022. Unfortunately, the company goes bankrupt in 2025, and Tom loses his entire investment. Although he can claim loss relief to offset the £50,000 loss against his income tax, his deferred CGT liability of £10,000 (from a previous gain) must still be paid because the investment is no longer valid for EIS relief.
CGT Rate Changes:
CGT rates may change over time, which could impact the overall effectiveness of deferring CGT under EIS. If CGT rates increase in the future, investors who deferred their CGT liabilities may end up paying a higher rate of tax when the deferred gain eventually becomes due.
This is particularly relevant for long-term investors who may defer gains for several years and could be affected by future tax reforms.
Example: Olivia defers a £200,000 capital gain in 2024 by investing the proceeds into EIS shares. The current CGT rate on shares is 20%, meaning Olivia would have faced a £40,000 CGT liability. However, if the CGT rate increases to 25% by the time she sells her EIS shares in 2027, she will now be liable for £50,000 in CGT, a £10,000 increase due to the rate change.
Reinvestment Risk:
If an investor continuously reinvests in EIS shares to defer CGT indefinitely, they must carefully manage their investments to ensure that all subsequent reinvestments qualify for EIS relief. Failure to do so could lead to an unexpected CGT liability becoming payable.
Additionally, reinvestment into higher-risk companies increases the chance of losing capital, which may reduce the overall benefits of CGT deferral.
Documentation and Record-Keeping Requirements
To claim CGT deferral and exemption under EIS, investors must keep detailed records of their investments and ensure that they meet the scheme’s eligibility requirements. The following documents are essential for claiming tax reliefs:
EIS3 Certificate:
The EIS3 certificate is issued by the company in which the investment is made and serves as confirmation that the investment qualifies for EIS relief.
Investors must retain this certificate as evidence of their investment’s EIS status. It is also required when claiming CGT deferral or exemption on the Self-Assessment tax return.
Self-Assessment Tax Return:
Investors must complete the appropriate sections of their Self-Assessment tax return to claim EIS reliefs, including CGT deferral and exemption.
They will need to provide details of the original gain, the date of reinvestment into EIS shares, and the amount of the gain being deferred.
Timing of Reinvestment:
Investors must ensure that their gains are reinvested within the required three-year period before or after the gain is made. Missing this window will result in the loss of CGT deferral relief.
Example: Mark sells a second home in 2023, realising a £150,000 gain. He reinvests £100,000 of the gain into EIS-qualifying shares in 2024, but forgets to reinvest the remaining £50,000 within the three-year period. As a result, Mark must pay CGT on the £50,000 portion of the gain that was not reinvested in time.
Updates to EIS and CGT Regulations (as of October 2024)
As of October 2024, there have been a few important updates to the EIS and CGT regulations that investors should be aware of:
Extended EIS Sunset Clause:
The government has extended the sunset clause for the EIS, which was initially set to expire in 2025. The EIS will now continue to operate until at least 2030, providing investors with ongoing access to CGT deferral and exemption reliefs.
This extension is designed to further support the growth of early-stage companies and provide investors with confidence in using the scheme for long-term tax planning.
Increased Investment Limits for Knowledge-Intensive Companies:
The investment limit for knowledge-intensive companies (which focus on innovation, R&D, or technology) has been increased from £2 million to £3 million. This change makes EIS an even more attractive option for investors looking to support high-growth sectors while benefiting from significant tax reliefs.
The CGT deferral and exemption provisions remain applicable for these higher investment limits.
Potential CGT Rate Changes:
While there have been no formal changes to CGT rates as of October 2024, there are ongoing discussions in government regarding potential increases in the CGT rates for higher-rate taxpayers. Investors who are using CGT deferral through EIS should monitor these developments closely, as any changes could affect the timing of their tax liabilities.
Risks and Considerations
Investing through the EIS can offer significant CGT deferral and exemption benefits, but it is not without risks. The potential loss of EIS status, early disposal of shares, changes in CGT rates, and reinvestment risks all require careful consideration. Investors must stay informed about the latest updates to the scheme and ensure they comply with the documentation and record-keeping requirements to fully benefit from the available reliefs.
By strategically using EIS, SEIS, and VCT (as discussed in previous sections), investors can optimise their tax planning while supporting high-growth, innovative companies. However, these tax-efficient schemes should always be used as part of a broader investment strategy that takes into account both the tax benefits and the inherent risks involved.
Hypothetical Real-Life Case Study: How Robert Bailey Used EIS to Defer CGT
In this hypothetical case study, we’ll follow the journey of Robert Bailey, a British investor, as he navigates the Enterprise Investment Scheme (EIS) and Capital Gains Tax (CGT) deferral in the UK. Robert, like many high-net-worth individuals, is seeking a way to manage his CGT liabilities effectively while supporting small businesses in the UK.
Background
Robert, aged 45, is a higher-rate taxpayer and a seasoned investor in property and shares. In early 2024, he sold one of his rental properties located in London, making a substantial capital gain. This gain triggers a significant CGT liability, and Robert is keen to explore ways to defer or reduce this tax burden while also pursuing investment opportunities in high-growth businesses.
Property Sale: Sold in January 2024 for £600,000.
Original Purchase Price: £300,000.
Capital Gain: £300,000.
CGT Liability: As a higher-rate taxpayer, Robert faces a CGT rate of 28% on the gain from the sale of his rental property, which is considered residential property. Therefore, his CGT liability on the £300,000 gain would be £84,000 (£300,000 x 28%).
Exploring the EIS Option
In an effort to manage this tax liability, Robert consults his financial adviser, who suggests he consider using the Enterprise Investment Scheme (EIS). EIS provides generous tax reliefs, including CGT deferral. By reinvesting his gains into an EIS-qualifying company, Robert could defer the £84,000 CGT, allowing him to support high-growth businesses while postponing the tax payment.
Step 1: Selecting the EIS-Qualifying Company
Robert’s adviser recommends investing in a technology start-up that has been approved for EIS. The company, Tech Solutions Ltd, is focused on developing innovative software for the education sector and qualifies for the scheme under the EIS regulations. Robert is excited about the company's potential for growth and decides to move forward with the investment.
Investment in EIS-Qualifying Company: £200,000 into Tech Solutions Ltd in March 2024.
Step 2: Deferring CGT
By investing the £200,000 into an EIS-qualifying company, Robert is able to defer the CGT on a portion of his £300,000 capital gain. Specifically, the £200,000 investment allows him to defer CGT on £200,000 of the capital gain.
Deferral of CGT: £200,000 of the £300,000 gain is deferred, which translates to a deferral of £56,000 in CGT (£200,000 x 28%).
Now, Robert only faces a CGT liability on the remaining £100,000 of his gain from the property sale. His immediate tax bill is reduced from £84,000 to £28,000 (£100,000 x 28%), providing him with immediate tax relief and freeing up capital for further investments.
Step 3: Claiming EIS Income Tax Relief
In addition to deferring CGT, Robert is eligible to claim 30% income tax relief on the £200,000 he invested in Tech Solutions Ltd. This provides an immediate reduction in his income tax liability for the 2023/24 tax year.
Income Tax Relief: £200,000 x 30% = £60,000.
This means that Robert can reduce his income tax liability by £60,000 in the 2023/24 tax year. Since he’s a high-rate taxpayer, this is particularly valuable in reducing his overall tax burden.
Step 4: Holding Period and CGT Exemption
To qualify for CGT exemption on any future gains from the sale of the EIS shares, Robert must hold his shares in Tech Solutions Ltd for at least three years. If he sells the shares before this three-year holding period, he risks losing the CGT exemption and would be liable to pay any deferred CGT on the original gain.
Scenario 1: Successful Investment and CGT Exemption
Let’s assume that Tech Solutions Ltd performs exceptionally well over the next few years. By 2027, Robert’s investment in the company has grown significantly, and the value of his shares has increased to £400,000.
Gain on EIS Shares: £400,000 - £200,000 (original investment) = £200,000.
Since Robert has held the shares for more than three years and Tech Solutions Ltd has maintained its EIS status, he qualifies for complete CGT exemption on the £200,000 gain made from the sale of his EIS shares. He pays no CGT on this gain, allowing him to keep the entire profit.
Furthermore, the original £56,000 CGT that was deferred in 2024 remains deferred indefinitely, as long as Robert reinvests the proceeds from the sale of his EIS shares into another EIS-qualifying company.
Scenario 2: Loss on EIS Investment and Claiming Loss Relief
In a less favourable scenario, let’s assume that Tech Solutions Ltd does not perform as expected, and by 2027, the company goes bankrupt. Robert’s shares are now worthless, and he has lost the entire £200,000 investment.
Although this outcome is unfortunate, Robert can still claim EIS loss relief to offset his losses against his income tax liability. The amount of loss that can be claimed is calculated after deducting the 30% income tax relief already claimed.
Allowable Loss: £200,000 - £60,000 (income tax relief) = £140,000.
Loss Relief: Robert can offset this £140,000 loss against his income at his marginal tax rate (45% for higher-rate taxpayers).
Income Tax Saving: £140,000 x 45% = £63,000.
Thus, Robert can claim £63,000 in loss relief against his income tax, partially mitigating the financial impact of his failed investment. The deferred CGT of £56,000 would still need to be paid because the investment did not lead to a full exemption.
Step 5: Reinvestment for Further CGT Deferral
After the sale of his EIS shares in 2027, Robert can reinvest the proceeds into another EIS-qualifying company. This allows him to continue deferring the £56,000 CGT liability from 2024. If he consistently reinvests in EIS-qualifying companies, he can indefinitely defer his CGT liabilities, optimising his tax position while supporting UK start-ups.
This hypothetical case study of Robert Bailey demonstrates how the EIS can be a valuable tool for managing Capital Gains Tax in the UK. By reinvesting gains into EIS-qualifying companies, Robert successfully defers a portion of his CGT liability while also benefiting from income tax relief. Depending on the performance of the investee company, Robert can potentially eliminate CGT on future gains or claim loss relief if the investment does not perform as expected.
The flexibility of the EIS, combined with the substantial tax reliefs it offers, makes it an attractive option for investors like Robert who seek to support high-growth businesses while optimising their tax strategy. However, as with any investment, it is essential to carefully assess the risks and ensure compliance with the EIS requirements to fully benefit from the scheme.
FAQs
Q1: What is the maximum CGT deferral period when investing through the Enterprise Investment Scheme (EIS)?
A: There is no maximum CGT deferral period under EIS, as long as you continuously reinvest in EIS-qualifying shares. The CGT is deferred until the shares are sold, transferred, or the company loses its EIS status.
Q2: Can you defer CGT on residential property gains through EIS?
A: Yes, you can defer CGT on gains from the sale of residential property by reinvesting the gain into EIS-qualifying shares, provided the investment is made within the required timeframe.
Q3: Do you have to claim income tax relief to qualify for CGT deferral through EIS?
A: No, you can claim CGT deferral through EIS even if you do not claim the 30% income tax relief on your EIS investment.
Q4: What is the deadline for reinvesting gains into EIS shares to qualify for CGT deferral?
A: You must reinvest your capital gain into EIS shares within three years before or three years after the gain arises to qualify for CGT deferral.
Q5: Can you claim both CGT deferral and CGT exemption on the same EIS investment?
A: Yes, you can defer CGT on the gain reinvested into EIS shares and claim CGT exemption on any future gains made from the sale of the EIS shares, provided the shares are held for at least three years.
Q6: Are there limits on the amount of gain you can defer through EIS?
A: No, there is no maximum limit on the amount of capital gains that can be deferred through EIS investments.
Q7: Does deferring CGT through EIS reduce your CGT allowance for the year?
A: No, deferring CGT through EIS does not affect your CGT annual exemption. The deferred gain is simply postponed until a later date.
Q8: What happens to deferred CGT if you die while holding EIS shares?
A: Upon death, the deferred CGT liability is extinguished, meaning no CGT is payable on the deferred gains.
Q9: Can you transfer your EIS shares to a spouse or civil partner without triggering CGT?
A: Yes, you can transfer EIS shares to a spouse or civil partner without triggering CGT, and the CGT reliefs will continue to apply as long as the qualifying conditions are met.
Q10: What documentation do you need to claim CGT deferral through EIS?
A: You need an EIS3 certificate issued by the company confirming that the investment qualifies for EIS, along with proof of the original gain and the date of reinvestment.
Q11: What is the impact of losing EIS status on deferred CGT?
A: If the company loses its EIS status within the required three-year holding period, the deferred CGT becomes payable immediately.
Q12: Are dividends from EIS shares subject to income tax?
A: Yes, dividends received from EIS-qualifying shares are subject to income tax, as EIS does not provide dividend tax relief.
Q13: Can you claim CGT deferral for gains that arise from a business sale?
A: Yes, gains from the sale of a business can be deferred through EIS by reinvesting the gain into EIS-qualifying shares.
Q14: Is CGT deferral under EIS available for gains on overseas assets?
A: Yes, you can defer CGT on gains from overseas assets through EIS, provided you are a UK resident for tax purposes.
Q15: What happens if you reinvest only part of your gain into EIS shares?\
A: If you reinvest only part of your gain, you can defer CGT on that portion of the gain, while the remaining part of the gain will be subject to CGT.
Q16: Can losses on EIS shares be used to offset gains on other assets for CGT purposes?
A: Yes, losses on EIS shares can be offset against gains on other assets, or you can offset the loss against your income tax liability under loss relief rules.
Q17: Can you carry forward unused CGT deferral relief to future tax years?
A: No, unused CGT deferral relief cannot be carried forward. You must claim it in the tax year in which the qualifying investment is made.
Q18: Does reinvesting gains into Venture Capital Trusts (VCT) provide CGT deferral like EIS?
A: No, VCTs do not offer CGT deferral. However, VCTs provide CGT exemption on gains made from the sale of VCT shares after five years.
Q19: Can you defer CGT on gains realised before the tax year 2024-2025 using EIS?
A: Yes, as long as the gain was realised within three years before the investment in EIS shares, CGT deferral can still be claimed.
Q20: How does the EIS deferral relief work if you are non-resident for part of the tax year?
A: If you become non-resident for UK tax purposes, your deferred CGT may become payable immediately unless certain conditions are met under UK tax residency rules.
Q21: Does deferring CGT under EIS apply to gains made from the sale of cryptocurrency?
A: Yes, CGT deferral under EIS can apply to gains made from the sale of cryptocurrency, provided the gains are subject to UK CGT.
Q22: Can EIS shares be held in a self-invested personal pension (SIPP)?
A: No, EIS shares cannot be held within a self-invested personal pension (SIPP), as they are not eligible investments for pension schemes.
Q23: Does claiming CGT deferral under EIS affect your eligibility for the annual CGT exemption?
A: No, claiming CGT deferral does not affect your entitlement to the CGT annual exemption for gains on other assets.
Q24: Can CGT deferral under EIS be combined with Entrepreneurs' Relief?
A: No, you cannot claim both CGT deferral under EIS and Entrepreneurs' Relief on the same gain.
Q25: Can you claim CGT deferral if the company ceases to qualify for EIS after the investment?
A: No, if the company ceases to qualify for EIS after the investment, the deferred CGT becomes payable, and you lose the deferral benefit.
Q26: Can you transfer your EIS shares into a trust without triggering CGT?
A: No, transferring EIS shares into a trust is considered a disposal and may trigger a CGT liability unless specific exemptions apply.
Q27: Can you invest in an EIS through a crowdfunding platform and still qualify for CGT deferral?
A: Yes, you can invest in an EIS-qualifying company through a crowdfunding platform and still claim CGT deferral, provided all EIS conditions are met.
Q28: Are there restrictions on the types of businesses that qualify for EIS and CGT deferral?
A: Yes, businesses in sectors such as banking, insurance, and property development do not qualify for EIS, and therefore, CGT deferral is not available for investments in these sectors.
Q29: Can EIS shares be held jointly between spouses or civil partners for CGT purposes?
A: Yes, EIS shares can be held jointly, and both parties may be eligible for CGT deferral and exemption, as long as the total investment meets EIS requirements.
Q30: Does the three-year holding period for CGT exemption restart if you reinvest EIS proceeds?
A: No, the three-year holding period for CGT exemption does not restart if you reinvest the proceeds into another EIS-qualifying company, but it applies to each new investment.
Q31: Is there a minimum amount that you need to invest in EIS shares to qualify for CGT deferral?
A: There is no minimum investment required to qualify for CGT deferral under EIS, but the investment must be in a company that qualifies for EIS relief.
Q32: Can you invest in multiple EIS companies and still defer CGT on one large gain?
A: Yes, you can spread your investment across multiple EIS-qualifying companies and defer CGT on one or more gains, as long as the total amount reinvested is sufficient.
Q33: What happens if the company you invested in goes public within three years of your EIS investment?
A: If the company goes public within three years, the shares may lose their EIS-qualifying status, which could lead to the immediate payment of deferred CGT and the loss of other EIS reliefs.
Q34: Can you use loan capital to invest in EIS and claim CGT deferral?
A: No, only investments made with actual capital, not loan funds, qualify for EIS relief, including CGT deferral.
Q35: Is there a deadline for reporting CGT deferral under EIS to HMRC?
A: Yes, you must report CGT deferral on your Self-Assessment tax return for the tax year in which the investment is made, within the normal filing deadlines.
Q36: Does claiming CGT deferral under EIS affect your personal allowance?
A: No, claiming CGT deferral under EIS does not affect your personal allowance for income tax purposes.
Q37: Can you hold EIS shares in a company you are actively involved in and still claim CGT deferral?
A: No, you cannot claim EIS relief, including CGT deferral, on shares in a company where you are a director or employee, except in certain limited circumstances.
Q38: Does the company need to apply to HMRC for EIS status before you can claim CGT deferral?
A: Yes, the company must apply to HMRC for approval under the EIS scheme, and only after approval can investors claim CGT deferral.
Q39: Can you claim both CGT deferral and Inheritance Tax (IHT) relief through EIS investments?
A: Yes, EIS shares can qualify for both CGT deferral and IHT relief, provided the shares are held for at least two years before death for IHT purposes.
Q40: Does the CGT deferral end if the company in which you invest merges with another firm?
A: If the merger causes the company to lose its EIS-qualifying status, your deferred CGT may become payable immediately.
Disclaimer:
The information provided in our articles is for general informational purposes only and is not intended as professional advice. While we strive to keep the information up-to-date and correct, Pro Tax Accountant makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the website or the information, products, services, or related graphics contained in the articles for any purpose. Any reliance you place on such information is therefore strictly at your own risk.
We encourage all readers to consult with a qualified professional before making any decisions based on the information provided. The tax and accounting rules in the UK are subject to change and can vary depending on individual circumstances. Therefore, Pro Tax Accountant cannot be held liable for any errors, omissions, or inaccuracies published. The firm is not responsible for any losses, injuries, or damages arising from the display or use of this information.