Investing in the dynamism of Birmingham
Midlands-based businesses could offer attractive prospects for investors, and often qualify for the tax-efficient...read more
The Enterprise Investment Scheme, we believe, is one of the investment sector’s best-kept secrets. Despite helping 26,000 privately-owned small businesses to access £16bn worth of funding for growth over the past 25 years, and securing attractive tax-efficient returns for investors in the process, the scheme has a relatively low profile.
That is now changing, however, as savers seek out new opportunities to plan for their long-term financial needs in the face of increasing restrictions elsewhere.
Most obviously, the once-generous rules on contributions to private pension plans have been steadily curtailed. Today, most investors are limited to annual pension contributions of no more than £40,000; moreover, higher earners, with annual incomes of more than £150,000, get a smaller allowance – as little as £10,000 a year for those with incomes of more than £210,000. The lifetime allowance, which levies tax charges on pension funds worth more than £1.03m, is also a problem for increasing numbers of people.
By contrast, the EIS offers much more generous allowances, with investors able to put up to £1m a year into qualifying companies. For many savers, the scheme, therefore, represents an increasingly valuable opportunity as a complement to pension saving, particularly as it may also be a more flexible option. Investors must hold on to their EIS shares for only three years to retain their tax incentives; pensions, by contrast, can’t be accessed until age 55 at the earliest.
Those tax incentives are certainly alluring, spread across income tax, capital gains tax and inheritance tax:
It’s important, however, not to let the tax tail wag the investment dog. After all, tax reliefs aren’t much use to investors who end up losing their starting investment.
It’s only fair to point out that the Government offers these tax breaks partly because it recognises the high risk of EIS qualifying companies, due to their illiquid nature. To be eligible for the scheme, companies must meet some restrictive tests: amongst other criteria, they must have assets of no more than £15m, fewer than 250 employees and be less than seven years’ old. These small, early-stage businesses are, by their nature, more likely to fail than larger more established companies.
That said, the best of these privately-owned companies also tend to deliver much more exciting returns than their larger counterparts trading on recognised stock exchanges. And investors can mitigate the risks of EIS investment through diversification. While would-be EIS investors do have the option of investing in individual companies with EIS-qualifying status – including many businesses on equity crowdfunding platforms – it is also possible to get exposure through a managed fund of such businesses run by a specialist asset manager. Such vehicles represent a potential way to spread your bets.
There are no sure things in investment, but the tax breaks on the EIS, allied with the opportunity to build a portfolio of shares in potentially high-growth companies, are a tempting mix for long-term savers*. They are likely to be particularly attractive to those who are running out of pension allowance.
Indeed, the secret appears to be getting out there, with official figures suggesting EIS popularity has surged in recent years.
Figures from HM Revenue & Customs reveal that in the 2016-17 financial year, the most rece#_edn7nt period for which data is available, some 3,470 companies raised a total of £1.8bn of funds under the EIS, though this was an initial estimate that HMRC expects to increase. In 2015-16, 3,545 companies raised £1.9bn of funds.
This won’t be a scheme for everyone. Investors will need to be prepared to accept the risk of partial or total losses, significant volatility over the short term, and to be patient. But for investors seeking out new opportunities to maximise the financial provision they are making for the long term, then EIS may be worth considering with your independent financial, legal and tax advisor.