Tax Bite - EIS deferral relief/SEIS reinvestment relief: often forgotten
EIS deferral relief/SEIS reinvestment relief: often forgotten
The Enterprise Investment Scheme (EIS) is a UK venture capital scheme renowned for the generous tax reliefs it offers investors when investing in private companies.
Along with its related relief (SEIS, for smaller start-up companies,) it provides income tax relief on the amount invested and a CGT free exit if all the conditions are met in relevant periods.
But often forgotten is the lesser known benefit EIS deferral relief, which enables investors to defer the payment of an existing CGT bill up to £2 million to a later year. The SEIS version operates a little differently - rather than a deferral it allows 50% of a gain reinvested to be tax exempt. These are separate reliefs which have broadly the same qualifying conditions as the EIS/SEIS income tax reliefs but with some important differences.
1. What is EIS deferral relief?
It allows investors to defer the payment of an existing CGT bill to a later year, should an amount equal to the gain be reinvested into EIS-eligible shares. If the conditions are met, the investor can treat a gain made on any kind of asset as effectively delayed until the EIS shares are sold.
The maximum an individual can invest in the EIS per tax year is £1 million (rising to £2 million provided all capital over £1 million is invested into knowledge-intensive companies). In turn, this is the maximum value of a gain that can be deferred via EIS deferral relief.
2. How does EIS deferral relief work?
It is not the actual cash from a gain which must be reinvested, rather if a capital gain is realised (on the sale of any asset), and there is an EIS investment in the period from one year before up to three years after that capital gain being realised, EIS deferral relief may be claimed.
The process can be repeated – so when the new EIS shares are sold with (hopefully) the actual gain being tax free and the deferred gain from the previous asset falling into charge to tax, that deferred gain can be deferred again if a new EIS investment is made that falls within the conditions for the CGT deferral.
The rate of tax that is charged on the deferred gain when the EIS shares are sold is likely to be still determined by what the original asset was. So, if it was UK residential property that deferred gain will be taxed at 28%. However, the legislation is not clear on this point and there is an argument that the rate would be the normal rate of CGT of 20%.
Where the original gain qualified for business asset disposal relief (old entrepreneurs’ relief) when it comes back in to charge on sale of the EIS shares the 10% tax rate will apply.
3. What are the conditions and who can benefit?
The rules are broadly the same as for EIS income tax relief in terms of the type of company and shares that must be invested in (e.g., trading company, size of company and must not carry on excluded activities, EIS shares must be held for at least 3 years).
However there are some important differences between the rules for EIS deferral relief and EIS income tax relief:-
- In order to qualify for EIS income tax relief, it is not a requirement for individuals to be UK-based. However, to be eligible for EIS deferral relief the individual has to be UK resident.
- For EIS deferral relief, the individual cannot be an employee of the investee company but can be a director and can have a shareholding of any size (unlike EIS income tax relief where the maximum shareholding for an EIS shareholder and his or her associates is 30%).
What this means is that a person can qualify for EIS deferral relief without necessarily qualifying for EIS income tax relief. Importantly, and unlike EIS income tax relief, people can reinvest into their own companies and potentially qualify for EIS deferral relief.
4. What are the risks of EIS deferral relief?
The investor would be wise to retain funds to cover the tax on the deferred gain in an accessible place for three years in case the relief is withdrawn:
- Changes to UK residency: should the investor cease to be a UK resident within three years of investment, their gain will cease to be deferred.
- Changes to EIS eligibility: should the company cease to be EIS-qualifying within three years of investment, the gain will cease to be deferred. This may not be in the investor’s control.
It should also be noted that when the deferred gain falls in to charge to tax, CGT is payable at the rate in force at the relevant time. So, in theory, if CGT rates go up more tax could end up being paid on the deferred gain.
5. Is SEIS reinvestment relief different to EIS deferral relief?
Yes it is.
Rather than a deferral of the gain it is a complete exemption for half of the gain reinvested. The rules are broadly similar in terms of what can be reinvested and when but the rules about qualifying reinvestments are stricter in that SEIS reinvestment relief can only be claimed if SEIS income tax relief has been claimed too. This means that the usual investor connection tests have to be met (principally that they must not hold more than 30% of the share capital (and various other 30% measures)). So, the relief is more restricted but more generous if it applies.
For example, if someone has a gain on a residential investment property that would be taxed at 28% then they can convert that to a 14% tax rate if a suitable SEIS investment is made.
If you are aware of clients who have made:-
- capital gains, they should be reminded of this relief in case new investment opportunities arise for them in the future (possibly in their own companies); and/or
- EIS investments, they should be reminded of this relief in case they have made/will make capital gains in the year before or in the 3 years afterwards.
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