EIS ‘funds’ are in reality a series of individual investments into individual companies with the fund ‘manager’ holding a series of discretionary investment management agreements with the respective investors in the fund.
Funds are excluded from the definition of collective investment schemes and are governed under separate Treasury rules. Activities of the funds are covered by the EU’s Markets in Financial Instruments Directive.
Due to the discretionary investment management structure of the agreements and the Mifid coverage, managers must hold regulatory permissions to manage and advise on investments - and clients will either be retail investment clients or professional clients as defined under the directive.
A critical point is whether the fund is approved or unapproved. This is not a regulatory term and applies to HMRC registration.
To be classed as HMRC approved, Mr Kiernan says the EIS prospectus must be reviewed by HMRC.
If the approved fund invests at least 90 per cent of its assets in approved investments within the 12 months following fund closing, investors in the fund will be treated as having made the EIS investments as at the date the fund closes.
Mr Kiernan says this offers a clear determination of the tax year for which income tax relief can be obtained.
As well as 90 per cent of the capital being invested within 12 months, the fund must also invest in at least four underlying companies and must not make investments until it is officially closed.
However, the majority of EIS funds are ‘unapproved’ as this is a more flexible approach, Mr Kiernan explains.
Tax relief for unapproved funds is granted at the time the underlying investment is made and the fund manager can make investments over two years.
Income tax relief is available across two tax years (at 30 per cent), there are no restrictions on the number of investments or the timing of the investments and the minimum investment by each investor in each EIS qualifying company is £500.
Strategies
There are two main types of investment strategies that EIS fund managers follow: capital preservation or capital growth.
With a capital preservation strategy, Mr Kiernan says the investment manager will target modest returns with the main aim to keep the risk of capital loss as low as possible and allowing the tax reliefs to boost returns.
Capital growth is where the fund aims for capital gains over a three to six year period. Investors will also still benefit from income tax reliefs in the short-term, tax free capital gains and inheritance tax relief in the medium-term and loss relief should the investment fail.
The risk of the investment with this latter approach is generally greater, according to Mr Kiernan, and therefore the investor needs comfort that they will benefit from a balanced portfolio with high probability of a capital gain.
Mr Kiernan says: “This structure is favoured by the government as it promotes investment in the way EIS is designed to benefit small start-up companies.”
John Thorpe, business line manager for EIS at Octopus Investments, says as EIS have become more widely used as part of a diversified portfolio, the market has matured and there are a number of different providers offering a range of investment strategies.
He says EIS should be considered as a long-term investment, as investors must be prepared to leave their money invested for at least three years from the date of investment in order to take advantage of the tax reliefs on offer.
Mr Thorpe says: “As with any investment the value may fall as well as rise. Smaller companies (with less than 250 employees), by their nature, will have a higher risk profile than, for example, the larger companies of the FTSE 100 but by the same token have the ability to delivers greater earnings growth over the long term.”
