Why EISs can have many advantages

The tax advantages of EISs are similar to those of a pension, but more generous. Providing the underlying investments made by the EIS are held for at least three years, investors receive 30 per cent up-front income tax relief, 100 per cent capital gains tax deferral for the life of the investment and 100 per cent inheritance tax after two years (provided the investments are held at time of death).

Any growth in the portfolio is free from capital gains tax and any losses can be offset against capital gains or income tax.

There are, naturally, investment restrictions, but these have been made less onerous in recent years. In order to qualify, investee companies are restricted on the maximum number of employees, the underlying trade of the company and a maximum amount of gross assets before and after the EIS investment.

John Thorpe, business line manager for EIS at Octopus, adds: “Over the years, the government has made slight changes to the rules surrounding EIS. These changes demonstrate the government’s support of EIS as it seeks to open them up to more investors, and to more companies looking for investment.”

Edward Guinness, manager of the Guinness AIM and Sustainable Energy EISs, points out that the extension of the gross assets limit from £7m to £15m, and the number of employees from 50 to 250 has meant that the lower end of the AIM universe – roughly 85 companies – is now available for EIS investment.

This means that there is now a good choice of investment strategies across the EIS sector.

Guinness, for example, provides a dedicated AIM EIS, investing in 6-12 AIM-listed companies. Octopus has also developed a range of EIS products with different risk profiles, including the Octopus Eureka EIS, which is invested in very small businesses across a range of industry sectors such as Calastone, Zoopla Property Group, and EKF Diagnostics, and aims to achieve significant capital growth. In contrast, the group’s Octopus EIS has a capital preservation mandate.

Mr Guinness says that stock selection will look very similar to that in a conventional portfolio. He adds: “We have a bias to companies with ‘traditional’ characteristics – visibility of profits, strong balance sheets and cash generation. The companies tend to be in sectors such as light industries, technology or early stage pharmaceuticals rather than the banks, utilities or insurers that dominate the larger company indices.”

He says that investing in AIM companies gives added transparency and also means that exiting from holdings is easier.

It is difficult to make generalisations about the performance of EISs. They are not readily comparable in the same way as, say, VCTs, so investors must drill down into the individual strategies to determine their credibility. Tax Shelter Report gives details of open EISs with individual prospectuses, which may hold performance data.

The tax advantages and investment criteria are subject to the whims of government ministers. In the recent budget, the chancellor vowed to clamp down on the potential misuse of EISs, in particular the use of “contrived structures to allow investment in low risk activities that benefit from income guarantees via government subsidies”. This has been true of some green energy schemes.

Nevertheless, the chancellor continued to support the structure in other ways: He announced he would make the Seed EIS (SEIS), aimed at providing support for start-ups, permanent.

Jason Hollands, managing director at Bestinvest says: “This is the extension of an aspect of the SEIS reliefs that originally had been temporary, namely the ability to eliminate a Capital Gains Tax liability by investing in SEIS as well as receive 50 per cent income tax relief, equating to up to 78 per cent relief.”

EIS schemes have a number of advantages: they allow retirees to reduce the income tax payable on their pension earnings, with IHT savings thrown in; they can also help those receiving large bonuses to reduce income tax in any given year.

There is also the altruistic view that EISs help small businesses and therefore help turn the wheels of the UK economy. Nevertheless, risks remain. Performance history is relatively difficult to disaggregate and charges can be high. They have a place in a portfolio, but are not a like-for-like replacement for a pension scheme.

Cherry Reynard is a freelance journalist

RISKS OF EIS

• Minimum holding period of 3 years

• Preferable holding period 3-5 years

• Invest into smaller companies, inherently more risky than larger companies

• No liquid secondary market for EIS shares

• Not listed on a stock exchange

• No dividends (as they are not tax free)

• Tax certificates can take anywhere from 3 to 18 months

• Capital may be at risk

REWARDS OF EIS

• Low correlation with equity markets

• Potential for high levels of tax free returns

• Loss relief available

• 30% income tax relief available to UK taxpayers

• No capital gains tax payable on growth

• Capital gains tax deferral for as long as the shares are held

• EIS shares should qualify for Business Property Relief – exempt from IHT after 2 years

• EIS are a well-established and accepted tax efficient investment

Source: Puma Investments