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The Enterprise Investment Scheme offers generous income tax and capital gains tax reliefs to investors in certain companies. These reliefs are available to “qualifying individuals” who subscribe for “eligible shares” in “qualifying companies” undertaking “a qualifying business activity”. Simple, isn’t it?

The purpose behind the scheme is to encourage investment in start up companies and so you can only buy new shares direct from the company itself and not from a third party. Such investments are high-risk but they have the potential to deliver high returns.

Being high-risk investments directly into an EIS company are most suited to high-net-worth individuals who understand the risk/reward trade-off. However those who are more risk averse might be tempted to invest in an EIS Fund which invests in a range of EIS companies so spreading the risk.

The rules, as with anything financial dreamed up by the government, are pretty complex. For example, those governing income tax relief on qualifying investments state that you have to have held the investment for at least three years. Providing you don’t have more than a 30% interest in the company your income tax liability is reduced by an amount equal to 20% of the amount invested. The minimum investment per company is £500 and the maximum is £500,000. You can also carry your income tax relief back a year.

As long as you keep your shares for at least three years there will be no capital gains tax (CGT) to pay when you sell, and you can also defer CGT on gains made from other non-EIS assets so long as they were made less than three years before the EIS investment or less than a year after it.

In an ideal world all our investments make money. But EIS investments tend to be high-risk, so if you sell at a loss (after taking the income tax relief into account) you can set that loss against any capital gains or income, either in the current or previous year. This means that even if the shares become totally worthless you effectively lose only 48p in the pound if you’re a 40% taxpayer or 40p in the pound if you’re a 50% taxpayer.

The EIS is also useful for inheritance tax (IHT) planning as it becomes exempt from IHT after you have held the investment for at least two years. This means that after IHT, CGT deferral and IHT reliefs have been applied, a £100,000 EIS investment would provide an additional £78,000 for your beneficiaries after your death.

The cumulative effect of EIS tax reliefs make them compare favourably with other tax-efficient vehicles, such as venture capital trusts (VCT), ISAs and pensions. For example, while a VCT scores over the EIS on income tax relief (30% v. 20%), it doesn’t offer CGT deferral or IHT relief. This is why EISs have been attracting three times as much money as VCTs over the last year.

Industry experts are predicting that this complex investment will take off in 2010 as investors look for a better return on their cash, particularly since the new 50% tax rate for those earning £150,000-plus kicked in last April.

See Also:

Category: Guide to City Jargon 

Category: Taxation

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