Last year was a bumper year for capital gains tax. Capital Gains Tax (CGT) receipts for 2020/21 were a record £14.3 billion. That’s 42% more than the previous tax year.1
CGT will be front of mind for many advisers and clients, and you may have clients who need to plan for a capital gain this year.
This article looks at a client scenario that illustrates how investing in an Enterprise Investment Scheme (EIS) can help clients target a growth investment and support their tax planning.
A powerful way for investors to target high growth
EIS-qualifying companies are in the early stages of their growth journey and unlisted.
Buying shares in these kinds of companies can help investors diversify their portfolio by adding venture capital.
Smaller companies can be more nimble than larger, more established companies so can take advantage of uncertain economic environments.
They also allow investors to target significant growth potential, because these companies are at the beginning of their growth curve.
Of course, with this high growth potential comes higher risk. To compensate for some of the risks involved in investing in early-stage businesses, EIS-qualifying investments allow investors to claim several tax reliefs. These reliefs can support a client’s tax planning, including gains planning.
EIS investors could benefit from 30% upfront income tax relief on the amount they invest (up to a value of £1million per year). Should an individual company in an EIS portfolio find success, that growth should be tax free. Where an individual company struggles, any losses are relievable (against income or capital gains tax). This is a powerful combination of tax reliefs when investing in a portfolio of early-stage companies where returns can be driven by some companies, while others fail.
Investors could also benefit from two further reliefs, which this scenario will show in more detail: capital gains deferral and relief from inheritance tax.
Understanding the risks
Before getting into the client scenario, it’s important to understand the risks. EIS investments are high risk and there are tax risks that you need to bear in mind too.
An EIS investment could fall in value, potentially to nil, and investors may not get back the full amount invested.
Shares in unquoted companies cannot easily be sold as an exit is only possible when an EIS company is sold on behalf of all investors. So a client’s investment should be considered illiquid and a long-term investment.
The shares of unquoted companies can also fall or rise in value more sharply than shares in larger, more established companies.
Several EIS tax reliefs depend on companies maintaining their EIS-qualifying status for at least three years. It is possible that a company might cease to be EIS-qualifying and EIS reliefs previously granted would need to be paid back.
Note that HMRC could change existing tax legislation. Tax treatment also depends on personal circumstances.
An ex-business owner wants to invest for growth tax-efficiently
Jin is 75 and a founder of an automotive business. His children have no interest in taking over the business, so instead he’s sold his business and plans to enjoy retirement before leaving his wealth to his family.
