The important role an EIS can play within a modern investment portfolio

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Tax efficiency, diversity and investment returns are three of the key factors that investors look for from their existing investment portfolio. But are investors missing a trick by not considering an Enterprise Investment Scheme (EIS) as part of their portfolio. Recent research suggests that only around 30% of financial advisers make use of tax advantaged investments such as EIS – are the other 70% missing a trick by not making use of them, and are their clients missing out on what can not only be a great diversifier, but also an incredibly effective tax planning tool?

EIS can be a great diversifier. Traditional investment funds will not provide investors access to early-stage companies, and through an EIS an investor can access investments into some of the newest, most vibrant and exciting companies the UK has to offer. They have minimal correlation to global stock markets too – they are less likely to be affected by economic shocks or significant falls in global stock market indices. 

EIS can provide investors with the potential for significant capital growth, but unlike traditional investments such as shares and fixed interest, the returns will be based on the growth of the business, and increase in the value of the underlying companies, rather than dividend and income payments, which has provided the majority of investment returns for decades, particularly in the UK. There is a long history of EIS funded companies making their investors outstanding returns on investment, but this shouldn’t take away from the fact that they are, and always will be high risk investments. Therefore, it is important that any investor who considers EIS has the correct risk profile, capacity for loss, and doesn’t envisage needing access to their funds for the medium term (5-7 years), as EIS shares are unquoted, and therefore illiquid.  An EIS should be viewed as something to compliment an existing portfolio, not something to replace it.

So how can an EIS compliment an existing portfolio? As mentioned, it can provide diversification, and the potential for increased investment returns, but the biggest benefit when considering its place within a portfolio is the tax reliefs on offer, and how they can interact with an investor’s existing investments.

Some investors will be happy with the tax efficiency afforded to them through tax-free ISAs and annual CGT allowances. However, when an investment portfolio or a gain reaches a certain size, these tax breaks simply don’t cut it anymore. No other investment in the UK offers the generous tax benefits afforded to EIS investors:

  • Income tax relief: 30% on up to £1m invested, increasing to £2m if at least £1m is invested in “knowledge intensive” businesses. Putting it simply, if you earn £100,000 per year and invest £50,000 in to an EIS, once you have received your EIS3 certificates you would be able to reduce your income tax payment by £15,000.
  • Capital Gains Tax deferral: A CGT liability can be deferred indefinitely if invested in to an EIS. This gain could have occurred up to 3 years before or 1 year after the date of EIS investment. This relief can be of significant benefit to an existing portfolio of traditional investments – a portfolio of direct shares, funds or property that has benefitted from significant growth will be liable to CGT. While investment growth is great, the amount of CGT payable on the gain can make some investors reticent to liquidate their holdings, so deferring via EIS can be a very attractive option.
  • Tax free gains: All gains on EIS investment are tax free if the investment is held for at least 3 years.
  • Inheritance Tax relief: The underlying assets in an EIS qualify for Business Relief (BR), which means that after holding the asset for 2 years they will become exempt from IHT if the investment is still held upon death.
  • Loss Relief: Significant downside protection, which provides relief at the investors marginal tax rate after initial income tax relief. EIS losses can be offset against either CGT or taxable income. The UK government is effectively underwriting a large chunk of downside risk – the maximum loss an additional rate taxpayer can incur is 38.5% of their invested capital. Again this benefit can be used to help deal with a capital gain from another asset in an investors portfolio.
  • Business Investment Relief (BIR):A UK resident/Non-Domiciled investor can make use of offshore funds to invest in to EIS without having to pay the remittance charge.

In summary, an EIS offers:

  • Greater tax efficiency, not just within the EIS itself, but for an investors overall portfolio
  • Greater diversity, an asset class and companies not available within traditional funds
  • Potential for improved investment returns

For more information on the Oxford Capital Growth EIS, click here.

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