How clients can target high growth and become more tax-efficient
15 March 2021
For professional advisers and paraplanners only. Not to be relied upon by retail investors.
EIS investments can be useful in tax planning where clients want exposure to venture investments, says Jessica Franks, Head of Tax at Octopus.
Higher net worth clients in their accumulation phase often exhaust their allowances when it comes to pension and ISA planning. Whether that’s annual allowances, or in the case of pensions, there’s also a lifetime allowance that restricts the amount a client can contribute over their life before incurring an additional tax charge.
These clients should consider additional ways to invest tax-efficiently for the future.
And those with an appropriate risk appetite and certain tax planning needs might want to consider investments that qualify under the Enterprise Investment Scheme (EIS).
The background to EIS
The Enterprise Investment Scheme was introduced in 1994 to encourage private investors to invest long-term capital into businesses with high growth potential. To compensate investors for some of the risk of investing in early-stage businesses, EIS-qualifying investments allow you to claim several tax reliefs.
Investors can claim income tax relief equal to 30% of the value of their investment, provided they hold the shares for at least three years.
Any growth in the value of EIS-qualifying shares is tax-free.
Losses made on an EIS company can be offset against either their capital gains tax bill or their income tax bill, depending on which better suits their needs.
An EIS fund manager can construct a portfolio of qualifying companies. In this scenario, if any of the individual holdings within an investor’s portfolio are sold at a loss, loss relief can be claimed even if the overall portfolio performance is positive. This is a significant benefit when making high risk investments.
And if an investor decides to reinvest the capital gain on the sale of another asset into an EIS-qualifying company, they can defer the gain until the EIS shares are sold. If they die while holding the EIS-qualifying shares, the capital gain will be eliminated on death.
In addition, EIS shares held at death should qualify for Business Property Relief if they have been held for at least two years, meaning they can be passed to beneficiaries free from inheritance tax.
Long-term investments that diversify a portfolio
For the right client, EIS can complement existing long-term investments. That’s because of the tax benefits available, and because they provide exposure to smaller companies.
For a company to qualify for EIS funding, it must be in the early stages of its growth journey. The company must also be unquoted (which includes being AIM-listed for these purposes). Buying the shares of these kinds of companies can bring significant growth potential and, bear in mind, significant risk to target that growth.
In addition to growth potential, smaller companies can follow different investment cycles from other areas of the investment market. So EIS investments can help diversify an investor’s portfolio by providing exposure to privately owned or AIM-listed companies that have the potential to be less correlated to wider markets.
A key to a door that’s normally locked
Of course, a client could choose to invest in a single EIS-qualifying company. Yet this can be a challenging way to access the benefits of EIS. It requires a client to conduct their own research, due diligence and admin. Individuals are also unlikely to have access to and knowledge of the most promising EIS opportunities.
Many clients prefer to invest in a portfolio of qualifying companies through a discretionary EIS service run by a specialist fund manager.
This brings access to a pipeline of investment opportunities you might be unable to find anywhere else, effective support to grow portfolio companies, and a team experienced in managing successful exits.
The team that manages the Octopus Ventures EIS Service, for example, has spent more than a decade growing their standing in the venture capital space. They have become one of the largest venture capital teams in Europe.
Their scale and reach, and also their reputation, which encourages many entrepreneurs to directly approach the team, mean Octopus Ventures can have exceptional deal flow.
That deal flow allows the team to be highly selective, choosing a few choice EIS opportunities from the thousands of companies seeking investment every year. And it means they see opportunities that many others won’t.
High growth potential means high risk
Investing in EIS companies is high risk. They are investments in early-stage companies. So an investment could fall in value, potentially to nil, and investors may not get back the full amount invested.
There are also tax, volatility and liquidity risks to consider.
Shares in unquoted companies cannot easily be sold, as it may take time to find a buyer. When investing in an EIS portfolio, an exit is only possible when each individual company is sold. So a client’s investment should be considered illiquid and therefore a long-term investment.
The shares of unquoted companies can also fall or rise in value much more sharply than shares in larger, more established companies.
A number of 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.
HMRC could also change existing tax rules, and tax treatment depends on personal circumstances.
Where to learn more
To find out more about EIS, visit https://octopusinvestments.com/our-products/enterprise-investment-scheme/
To learn about the Ventures EIS service offered by Octopus, sign up to our next webinar.
The Octopus Ventures EIS Service is not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: February 2021. CAM010767.
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