Tax reliefs
The EIS provides both income tax and capital gains tax relief to the investor. The investor's income tax liability for the year is reduced by 30% of the sums invested in the start-up company, up to the annual investment limit. This effectively reduces the cost of investment by 30% up to that limit (and capped at the investor's income tax liability). The current annual investment limited is £1 million, or £2 million for "knowledge-intensive companies". Knowledge-intensive companies are, broadly, companies that are carrying out a substantial amount of research and development by skilled employees.
An EIS investor who qualifies for income tax relief will also benefit from an exemption from capital gains tax on disposal of the EIS shares provided that they have owned the shares for at least three years. The investor can also defer capital gains tax arising on the disposal of a different asset by subscribing for EIS shares, provided that the subscription is made within specified periods.
Conditions
As the tax reliefs given are generous, there are numerous, complicated conditions that must be met for an investment to qualify for the EIS. Most of these conditions relate to the investee company, a key one being the "risk to capital condition". HMRC introduced this condition more recently in 2018 and it requires the investee company to be a true entrepreneurial, growing company carrying a significant risk of loss to capital for the investor. HMRC has explained that this condition is "principles-based" and has provided factors to consider in determining whether the condition is met.
The investee company must be carrying out a qualifying trade for the three-year period following the issue of the EIS shares. This condition is to ensure that the investee company is genuinely carrying on a commercial trade. Companies that carry out "asset-backed" activities, such as property development or financial activities, are excluded from the EIS.
As EIS relief is designed for investments in small, start-up companies, there are conditions that must be met relating to the size and age of the company. The value of the investee company's gross assets must not be more than £15 million before the share issue and £16 million after. The company must also have fewer than 250 employees, or fewer than 500 employees if it is knowledge-intensive. The EIS shares must also be issued within seven years of the company's first commercial sale, or within ten years for knowledge-intensive companies.
An EIS investor also has to meet certain conditions to qualify for the relief. They must not be connected with the investee company for a period of two years before their investment and three years after. This means that they must not be an employee or director of the company or already hold a material interest in the company. However, there is a tightly drawn exemption to this condition for angel investors. These are investors who become directors of the investee company at the time of their investment because they want to lend their expertise to the company. Angel investors will still qualify for EIS relief provided that the remuneration they receive for their directorship is reasonable and they were not previously connected with the company.
An EIS investor cannot qualify for relief unless their money is genuinely at risk for a period of time, generally three years. Relief previously granted can be withdrawn (essentially requiring the investor to pay back the income tax relief previously claimed) if the shares are sold within three years or other forms of value are received from the company during that period. Any attempt during that period to lock in an exit later, such as by granting of options, will also generally lead to a withdrawal of relief. One particular pitfall to avoid is that relief can be withdrawn if the company buys back shares from any investor (not just the investor in question).
Seed EIS (SEIS)
SEIS relief is a similar relief available to investors in smaller companies. The rules are based on the EIS rules, however the investee company is limited to raising £250,000 through SEIS investment. The investor benefits from a more generous income tax relief of 50% of the amount invested, however the annual investment limit for SEIS is lower at £200,000.
It is important to note that a company cannot qualify for SEIS if it has already taken EIS investment.
