Strategic options to aid tax planning

This article is part of
Investing in EIS - October 2014

The Enterprise Investment Scheme (EIS) market has been a well-established part of the investment adviser’s toolbox for many years now.

Starting in 1994, the EIS market has now reached a level of investment subscriptions of more than £600m a year, with more than £7.7bn has been invested since 1994.

While the scheme was established as a way of providing support and funding for smaller companies, it is the generous tax breaks that accompany an investment that make them attractive for investors and advisers alike.

It is important to note, however, that EIS investments represent a significantly higher level of risk as they involve taking long-term equity stakes in smaller companies. Investors also have to be able to commit to investing into an EIS for a minimum of three years, and preferably need to look at an EIS with a minimum five-year horizon.

Anyone considering whether an investment into an EIS is suitable for them should seek advice from their independent financial adviser.

That said, the tax benefits that come with an EIS do make them an attractive tool for sophisticated investors seeking ways of increasing their tax efficiency. With the 30 per cent income tax relief available to UK taxpayers on EIS investments of up to £1m per year, the most common usage for a client is likely to be as a tool for reducing an income tax bill.

They can also be used to defer capital gains tax liabilities, but this is only a deferral and not an exemption.

With the recent rises in UK house prices (up on average by 30 per cent during the past five years), coupled with the freezing of the inheritance tax (IHT) nil-rate band at £325,000 until April 2019, it is the eligibility for EIS investments to qualify for business property relief (BPR) after two years that is becoming increasingly attractive to investors.

The advantages of holding BPR-qualifying investments for IHT planning are twofold. First, after two years the investment should qualify for BPR and should therefore be exempt from IHT, as opposed to seven years if a gift is made.

Second, the individual retains control of their investment from day one. The investment still needs to be held for at least two years at the point of death, but the client is free to sell their investments, or they can move them from one BPR scheme to another without the two-year clock restarting.

EIS investments will become even more salient when the ability for investors to make large withdrawals from their pension pots comes into effect in April 2015. Many investors welcome the newfound freedom that comes with flexible drawdown, but any withdrawals from a pension could trigger a significant income tax bill. So the 30 per cent income tax relief available on an EIS investment would help to soften this blow.

Then after two years, the EIS investment should qualify for IHT relief under BPR, which would not have been the case if the money had remained within the pension. But again, it is important to seek advice, particularly when it comes to pension withdrawals.