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Tax-efficient investing – March 2016What do latest EIS changes mean for advisers and clients?
A growing number of advisers are using Enterprise Investment Schemes (EISs) for their clients and this trend is expected to continue.
Research commissioned by the EIS Association, and undertaken by Intelligent Partnership, found almost two-thirds of advisers expect to increase their use of EIS in the next 12 months.
Lower pension contribution limits and uncertainty around higher-rate tax relief were given as major contributing factors to the likely rise in use.
The research findings are supportive for an already growing EIS and Seed EIS (SEIS) industry. The 2013-14 tax year was a record for fundraising, with more than £1.5bn invested in EIS-qualifying companies and £168m through SEIS.
Since its creation in 1994, the EIS has provided more than £12.3bn to 22,900 smaller companies. In that time, the EIS regime has been through various changes to ensure it remains an effective funding vehicle for smaller companies, while offering suitable tax incentives for the private investors who provide the growth capital that underpins its success.
| REGULATIONS: The key changes to EIS |
• The purpose of the investment must be to promote business growth and development. • All investors must be ‘independent’ from the company at the time of the first share issue. • lThe EIS annual limit of £5m is now to include investments in subsidiaries or where trades are transferred in. • There is a new limit of £12m on the total lifetime investment a company may receive through EIS or venture capital trusts (VCTs), with some exceptions including ‘knowledge-intensive’ firms. • There is a new age limit of seven years from the first relevant commercial sale, with some exceptions including “knowledge-intensive” companies or companies that have already raised EIS or VCT funding. • EIS and VCT funds may not be used for the acquisition of existing companies. • With regards to “knowledge-intensive” companies, the lifetime investment limit is £20m instead of £12m and the age limit is 10 years from the first commercial sale. • Age limits will not apply where the investment represents more than 50 per cent of turnover averaged over the preceding five years though with a requirement that investment is used for development of new products or new markets. • The number of employees allowed in “knowledge-intensive” companies is being raised from 250 to 500. |
The industry has had to adapt to these changes, but it has continued to thrive as evidenced by the latest record fundraising.
Fresh changes became law in the Finance Act 2015. These mainly relate to the criteria used to determine companies’ funding eligibility and the levels of investment they can receive.
The changes are ultimately designed to ensure capital is targeted at the start-up and earlier-stage businesses that need it most.
The crucial question for an adviser is, ‘what do these changes mean for the advice I give to my clients?’
In this context, the potential for higher investment risk must be considered. Because it will become more difficult for companies that are more than seven years old to obtain EIS financing.
Funding will instead be focused on smaller or earlier-stage companies, and investment risks will in some cases increase.
There is no point speculating on the net effect of this change as only time will tell. However, it would be wrong to think EIS, and more latterly SEIS, have ever been anything other than a higher-risk investment. Their core purpose is to provide small and start-up companies with funding to help them grow.
Such businesses have always carried with them a higher degree of risk than later-stage or listed companies and that is why EISs and SEISs come with such generous tax reliefs.
The combinations of the respective 30 and 50 per cent income tax relief for EIS and SEIS, no capital gains tax (CGT) or inheritance tax after two years, and CGT deferrals continue to represent an attractive proposition for wealthy investors at a time when tax reliefs are being heavily curtailed in pensions.
| IN NUMBERS: EIS and SEIS |
■ £12.3bn - Amount of funds raised in EISs since the vehicle was launched in 1993-94 ■ 22,900 - Number of individual companies that have received investment through EIS ■ £168m - Amount raised through SEIS in the 2013-14 tax year |
Uniquely, these high-risk investment schemes also come with loss relief. This means that should the investee company fail, the maximum loss on any single company through an EIS is 38.5p in the pound for 45 per cent taxpayers. For SEIS, that comes down to a maximum loss of 27.5p.
Enlisting the services of a professional investment manager should go a long way in mitigating risks and minimising the likelihood of losses on any single underlying investment. The industry is home to many skilled managers with long and demonstrably successful track records.
While the most recent changes to the EIS regime do alter the parameters of the investment universe, they should in no way undermine the ability of competent fund managers to continue to pick good companies.
It is, of course, up to advisers to find the most appropriate investment managers for their clients.
An area where the EIS sector could improve is in the clear presentation of performance and other important information.
More standardised approaches would undoubtedly make advisers’ jobs easier.
Sarah Wadham is director general of the EIS Association
