At its core, the Enterprise Investment Scheme (EIS) is about assisting nascent companies by attracting investment funding with its attendant tax advantages. It may seem counterintuitive that a scheme designed to stimulate and grow youthful companies can also play an integral role at the end of individual’s life and beyond.
The fact is, however, that EIS - and its close relation, Seed Enterprise Investment Scheme (SEIS) – can be an effective tool for anyone engaged in Inheritance Tax (IHT) planning.
EIS is a potential complement to traditional methods of IHT planning such as trust planning, investing in companies qualifying for Business Relief (formerly known, and still often referred to, as Business Property Relief).
Unlisted shares and shares listed on the AIM market qualify for Business Relief if owned at the date of death providing they have been owned for at least two out of the last five years. This means they receive 100 percent relief against IHT.
Each method has its place in a properly formulated IHT strategy – the important point is to find that place and utilise it accordingly.
IHT planning is more complex than other forms of tax planning because there are multiple stakeholders (i.e. primary client, beneficiary and life tenants etc.). When creating a strategy it is important to consider the needs and objectives of all these stakeholders.
Starting at this point allows the appropriate vehicle to reveal itself.
Let’s take one common IHT planning scenario: leaving money to help children pay school fees. The trust is the obvious choice for protecting capital and saving it for future use.
But consider a situation in which you need to access capital but also want to leave to the next generation. This is where Business Relief comes into its own – the only investment that allows for 100 per cent IHT relief while giving access to, and use of, the capital.
Full relief is available on a business or an interest in a business, or shares in an unlisted company. Here, we need to consider the Alternative Investment Market (AIM), the second division of the London Stock Exchange, because AIM-listed shares are considered unlisted for the purpose of Business Relief. The one requirement is that the shares must have been held for at least two years before being transferred to the beneficiary.
EIS shares qualify for business relief in their own right and hence enjoy the same IHT exemption. This IHT exemption is complemented by a generous offering of other tax breaks. All make EIS an attractive growth investment for those who want to build something to pass on to the next generation.
There is an upfront 30 percent income tax relief on investment, an exemption from Capital Gains Tax (CGT) and the opportunity to defer other gains for CGT purposes by reinvesting them in qualifying EIS companies, and loss relief that effectively caps losses at 38.5 percent of the investment.
Accordingly, a £100,000 EIS investment brings income tax relief of £30,000, bringing the real investment cost down to £70,000. Should that stake double in value to £200,000, then there will be a tax-free capital gain of £100,000.
As we said earlier, however, the various IHT planning methods can work in tandem. For instance, capital held in a Business Relief-qualifying enterprise can be taken out and invested in an EIS. When that investment matures it can then be paid back into the Business Relief investment.
An additional benefit of taking the AIM route to EIS investment is that it is more liquid and can reside in an Individual Savings Account (ISA), bringing its own tax breaks in relation to income tax and CGT. The disadvantage is that these investments are often volatile.
Whereas EIS and SEIS offer fabulous tax benefits they are illiquid, which means that beneficiaries need to be patient. Providing they are happy to wait a few years they should benefit from a significant uplift in value with any deferred capital gains getting written off and an exemption from IHT. This represents an increase in assets of 66 percent after accounting for IHT relief, or nearly 100 percent if deferred CGT is involved as well.
Finally, one last piece of positive news regarding EIS investment and IHT planning. Seemingly, when an EIS investment matures, the Business Relief expires and the investor loses the two-year qualifying period for IHT exemption. However, provided that the investor re-invests the proceeds of the sale of the EIS company in a new qualifying asset the two years are in effect rolled over thanks to Replacement Property Relief
With different objectives for different portions of capital, IHT planning can be complex. No single tool is capable of doing every job at hand. That said, we believe that EIS can complement other methods of investment in order to bring about the desired outcome.