Tax advantages of EIS explained

1) Income tax relief: Investors in EIS will find 30 per cent income tax relief is granted on qualifying investments made, up to a maximum of £1m for the 2013 to 2014 tax year and a further £1m if carried back to the 2012 to 2013 tax year.

In order to retain this relief, Mr Thorpe says the investment must be held for at least three years.

2) Capital gains exemption: Where gains arise from holdings within the portfolio, Mr Thorpe says there is no capital gains tax.

3) Capital gains tax deferral: In addition, if you have made a capital gain that is taxable, Mr Thorpe says it can be invested into EIS shares and will be deferred for the life of the investment.

The gain must be invested into qualifying companies within three years from the date that it was realised, which means that investors can use an EIS investment to reclaim tax that they have already paid.

It is also worth noting that any deferred CGT liability is eliminated on death – so if an individual still holds the EIS shares when they die the tax liability on the gain they deferred in dies with them.

4) Loss relief: EIS qualifying holdings are eligible for loss relief, which Mr Thorpe says improves the overall post-tax risk/return profile of the investment.

For most investments, when normal shares fall in value Mr Thorpe says investors have an allowable loss, but then they face capital gains tax when they go up in value. Some specific investment types (such as Isas or VCTs) are free from CGT when they go up in value, but Mr Thorpe says there is no tax relief if they go down in value.

With EIS, however, losses attract relief. Any holding that has fallen in value at the time of sale will qualify for loss relief, irrespective of the overall portfolio performance - even if only one holding within a portfolio of 10 investments falls in value.

Mr Thorpe says investors can choose whether that relief is set against other gains, then or in the future, or against income tax in that year or for the year before.

“This can mean losses can be set against up to 50 per cent income tax if an investor paid that rate during the 2012 to 2013 tax year.”

5) Inheritance tax relief after two years: Provided funds remain deployed in trading activity by the EIS companies, Mr Thorpe says the investments should be eligible for business property relief.

Investments which qualify for BPR are excluded from an investor’s estate for inheritance tax purposes, if held for a minimum of two years and at time of death.

Mark Payton, managing director of Mercia Fund Management, says the high level of income tax and CGT reliefs, coupled with loss relief, means there is a large downside protection provided in the event that the investment fails.

Therefore, he says the tax advantages of EIS have the greatest impact to overall performance when applied to a capital growth focused investment strategy; compared with a low risk, low return strategy which primarily benefits from the initial income tax relief.