Introduction to the Enterprise Investment Scheme (EIS)

What is the Enterprise Investment Scheme UK?

The Enterprise Investment Scheme or EIS was introduced by the UK government in 1994 to help young businesses raise money. As investing in startups can be risky, EIS offers a range of attractive tax benefits to investors who buy shares in eligible companies. Investors can benefit from making a capital gains tax-free investment and receive income tax relief among other forms of tax breaks.  This article will look at how EIS works, which companies are eligible for it, and the tax reliefs available to investors.

Table of contents

• What is the Enterprise Investment Scheme UK?
• How the Enterprise Investment Scheme works
• How does investment in EIS work?
• How investors can claim EIS tax relief
• What are the overall benefits of EIS?

Who is EIS for?

Companies that qualify for EIS come from a wide range of sectors and industries. Broadly speaking, your company may be eligible if it has under £15 million in assets, less than 250 employees, and has been around for no more than 7 years. 

There are some higher limits applied to companies operating in some sectors involving research and development and innovation that we will come to later.

Anyone can invest in an EIS-qualified company but they may be best suited to wealthy people and very experienced investors. Investors are entitled to claim income tax relief on up to £1 million of investment each tax year and up to £2 million of investment into businesses that meet criteria around research and innovation.

What venture capital schemes can you apply for?

EIS is one of 4 venture capital schemes that you might consider applying for to get funding for your business, the schemes are:

• The Enterprise Investment Scheme (EIS)

• The Seed Enterprise Investment Scheme (SEIS)

• Social Investment Tax Relief (SITR)

• Venture Capital Trust (VCT)

Each of these has its own set of eligibility criteria which you should look into and different tax incentives for investors in your company.

How the Enterprise Investment Scheme works

The purpose of EIS is to help your company raise the money needed for it to grow. This is done by selling shares to investors who can benefit from receiving significant tax relief such as in the areas of income tax liability and capital gains tax.

You can raise up to £12 million in your company’s lifetime at a maximum rate of £5 million per year. These amounts also include money from other venture capital schemes.

How can EIS money be used?

The money raised must be used for qualifying business activity, that is either:

• a qualifying trade

• preparing to carry out a qualifying trade to start within 2 years of the investment

• research and development that should lead to a qualifying trade

Nearly all trades are ‘qualifying trades’ unless the business involves a significant amount of ‘excluded trades’ – a list of which you can find on the UK government website for EIS.

Which companies is EIS for?

EIS is for new, innovative companies who trade in a variety of sectors and industries. EIS-qualifying companies must meet a set of certain criteria. Essentially, a company must be trading in the UK, be focused on growth, and have the required size of operation. It must also not be working in one of the excluded trades. 

Restrictions on a company’s age and size are reduced for those operating in the areas of research and innovation – these businesses are known as ‘knowledge-intensive’ companies.

What are the eligibility criteria for EIS?

Here are some of the main criteria for EIS eligibility. To be able to raise funds via EIS, your company must:

• have started trading

• have a permanent presence in the UK

• not be listed on any stock exchange

• not control another company other than qualifying subsidiaries

• Not be controlled by another company, or have over 50% of its shares owned by another company

• not expect to close after completing a project or series of projects

• not have gross assets worth more than £15 million

• have less than 250 full-time employees

• carry out a qualifying trade

In addition, since 2018, investment should pose a ‘risk of loss of capital’ to the investor and be used to grow and develop your business such as by revenue and number of employees. These two conditions must be met in the eyes of the HMRC for an application for EIS to be successful. Risk of capital has to be present at the point when shares are issued and must be greater than the net investment return. The growth must not just be an objective of the company but something that will be the result of EIS investment.

What are ‘knowledge-intensive’ companies?

The HMRC determines which companies qualify as being ‘knowledge-intensive’ based on meeting conditions such as how much money and resources a business allocates to innovation and research.

Businesses in this category will either:

• want to raise more than £12 million in the company’s lifetime

• not have venture capital scheme investment on record within the first 7 years 

Being able to receive more funding over an extended period of time is a significant benefit for companies that qualify for EIS and meet these additional conditions.

How to apply for EIS?

When the company has been trading for four months, you can submit form EIS1 to the Small Companies Enterprise Center (SCEC) of HMRC. 

Once the EIS1 has been reviewed and the requirements met, the SCEC will issue an EIS3 certificate to show that your business is one of the EIS-qualifying companies.

What is EIS advance assurance?

Before raising the funding a company can request from HMRC an assurance that it will be one of the qualifying companies. As investing in early-stage companies poses a higher risk, many investors will like to see some proof that your company will qualify for EIS before buying shares, and this is where having pre-approval from HMRC will be useful in persuading them to invest.

It isn't mandatory to apply for advance assurance but it can avoid difficulties with investors later down the line if, for example, your application for EIS is rejected after you have sold some shares assuming that your business would qualify.

How to issue shares for EIS investments

If you received the HMRC’s advance assurance, are happy that your company qualifies for EIS, then it’s time to issue shares to your investors. You should be very thorough and accurate with documentation at this point because mistakes are hard to correct once shares are issued. It’s also important to check that the company still qualifies for EIS when you are ready to issue.

The shares you issue to qualify as EIS investments must be full-risk ordinary shares. They must be paid up in full when they’re issued.

How does investment in EIS work?

EIS investors can invest either directly or through a fund manager who builds a portfolio of investments. While riskier than some other investment options, buying shares early on in a company's life is a way to potentially make high returns if things start to take off.

EIS investments are seen as being risky so it may be a good idea to diversify your portfolio. They are an attractive option for experienced or wealthy investors and people who have larger income tax bills because of the allowances available. 

You should be aware that tax rules may change and seek professional tax advice for your circumstances.

What EIS tax reliefs are available?

The tax reliefs are a major attraction of EIS qualified companies for potential investors.

The main tax reliefs for EIS are:

• Income Tax relief – up to 30% on investments of up to £1 million and up to £2 million for investment in research and innovation companies

• Loss relief – if shares are sold at a loss, this can be set against income tax

• Capital Gains Tax relief – free for investments held a three-year minimum holding period

• Capital Gains reinvestment relief – tax can be deferred if reinvested into other EIS shares

Also, if someone inherits shares in an EIS qualified company they qualify for Business Property Relief (BPR) and get 100% inheritance tax relief. 

What is Loss Relief?

If an investor disposes of shares at a loss, the investor can set the loss against income either for the same tax year or for the previous one. This relief considers the higher-risk nature of investing in startups and early-stage companies.

What is Capital Gains Tax disposal relief?

If investors hold shares in your company for at least 3 years, then any capital gain is free. This is noteworthy because an early-stage company that is successful will experience rapid growth in size and value.

What is CGT reinvestment relief?

CGT payments can also be deferred if the gain is reinvested into buying shares in another company that is EIS-qualified.

Who is eligible for EIS tax relief?

There are two main restrictions that focus on investors being ‘connected’ to the company either by financial interest or employment. The company must also keep its EIS status.

You must follow the scheme rules so that your investors can claim and keep EIS tax reliefs relating to their shares. 

How much income tax relief can investors claim?

Through the Enterprise Investment Scheme (EIS), eligible investors can claim up to 30% income tax relief on investments up to £1 million per tax year. This extends to £2 million for investment in knowledge-intensive companies.

Investors can reduce tax by up to £300K from a maximum investment of £1 million in any one year, and double that when investment is in a knowledge-intensive business. There is no minimum investment amount for EIS. 

As EIS tax relief is allocated to individuals if someone is married or in a partnership both people could invest up to £2 million combined and receive up to £600K tax relief.

How investors can claim EIS tax relief

1. Investors must first check the company qualifies for EIS

2. Invest by buying ordinary shares

3. Receive the EIS3 certificate

4. Claim the tax relief using form EIS3

For Income Tax relief investors will need the EIS3 certificate. For CGT relief they don’t need to do anything if all the eligibility criteria are met. Loss relief can be triggered when the shares are sold or valued at nothing. The CGT deferral requires a personal tax return using EIS3.

What are the overall benefits of EIS?

EIS is important to founders, owners, shareholders and the general public for several reasons. For startups and young companies, it can provide an important source of early-stage funding that would otherwise be tricky to obtain considering the failure rate of new businesses. This is vital in keeping the UK economy thriving and leading in the area of innovation. 

Meanwhile, investors will benefit from some very significant tax reliefs to encourage their investment into higher-risk businesses. When a company achieves high growth, the investment can also become very lucrative.

Are you looking to fund an early-stage company or startup? We know the challenges and obstacles that this can bring. If you want to learn about another option that you may not yet have heard about, you can speak to us about a great way of funding your business without sacrificing any control.