The scheme offers investors a number of perks and incentives in return for investing in small, higher-risk companies.

The scheme plays a vital role in helping Britain’s start-ups. Investment made in EIS is intended for companies at the early stages of development, with relatively low levels of staff and assets.

For example, investors are offered income tax relief proportional to the cost of the shares they purchase through the scheme, and if they make a loss when they sell their EIS shares, they can claim loss relief – further cutting their tax bill.

Chancellor George Osborne announced sweeping changes to the EIS system in his 2011 Budget. Perhaps the most high-profile was the increase in income tax relief from 20% to 30%; this means that investors have even more reason to fund a company via EIS than before, and enhances a start-up’s chances of securing the right investment.

1. Income Tax Relief

You can claim up to 30% income tax relief on EIS investments, and this relief is yours to keep providing you hold on to the investment for at least three years. The most you can claim for the current tax year is £300,000 and you also have the option of claiming up to £300,000 against your income tax liability for the previous tax year. The amount of relief you receive isn’t allowed to be more than the income tax you pay. There’s is also no inheritance tax to pay on shares bought through EIS.

Table 1

Gross Investment in Shares £10,000

Less CGT deferral at 28% £(2,800)

Less income tax relief of 30% £(3,000)

Net cost of investment £7,000

The relief is generally given for the tax year in which the shares are issued but investors may treat some or all of the shares as issued in the previous year and claim relief in that previous year, subject to the maximum relief limit for the year. The shares must be held for a certain period or income tax relief will be withdrawn. Generally, this is three years from the date the shares were issued, or three years from the date the qualifying trade started, if later.

2. Capital Gains Tax Deferral

If you make a capital gain that is taxable, it can be invested in an EIS and the tax will be deferred for the life of the investment. You should remember, though, that the capital gains tax deferral is not available until you invest in qualifying companies. The capital gain can be from 36 months before the investment into qualifying companies or 12 months after. If you die while you still have your EIS, the tax deferred on your gain is eliminated.

Table 2

Gross Investment in Shares £10,000

Less income tax relief of 30% £(3,000)

Net cost of investment £4,200

There are no maximum or minimum amounts for deferral (although an individual company can accept a maximum of £2m of qualifying investment in any twelve months) and it does not matter whether the investor is connected with the company or not and there is no minimum period for which the shares must be held.

3. Capital Gains Tax Exemption

EIS tax relief exempts investors from the liability to capital gains tax when they dispose of their shares, provided that the disposal takes place at least three years after the issue of the shares (or the commencement of the trade if later) and also provided that EIS income tax relief has not previously been withdrawn. Any gain accruing to the investor on the sale, or disposal of shares is not liable to capital gains tax (for example, see Table 3). As mentioned above, this exemption does not apply to any gain deferred under the Deferral rules which subsequently become liable to Capital Gains Tax when the shares are disposed of.

Table 3

Realised value of a £10,000 investment after 3 years £20,000

Original net investment in shares after tax relief at 30% £(7,000)

Tax free Gain £13,000

4. Loss Relief

Loss relief is one of the most compelling features of an EIS because it can reduce the impact of losses from individual EIS investments and may improve the overall risk/return profile of your investment. The availability of loss relief makes an EIS different from other types of investment. Some investments, such as ISAs and Venture Capital Trusts, are free from CGT when they go up in value but there is no tax relief if they fall in value. An EIS, however, can offer both forms of relief whereby gains are not taxed and losses attract relief.

Table 4

The methods for claiming tax relief will differ depending on individual circumstances. Upon receipt of an EIS 3 certificate you can claim tax relief on the Self-Assessment Tax Return for the tax year in which the shares were issued.

Claims to relief can be made up to five years after the first 31 January following the tax year in which the investment was made.

If you receive the form after you have sent your tax return or if the shares were issued in a previous year, and/or if the claim is for capital gains deferral relief, complete the claim form incorporated within the EIS 3 and send to your tax office.

If you have an EIS 3 for a year for which you have not yet received a tax return, you can request a change to your PAYE tax code, or an adjustment to any Self-Assessment payment on account due. You will still have to make the claim itself on your tax return when you get it.* If you do not receive a tax return automatically, it can be obtained by contacting your tax office or by downloading it from the HM Revenue & Customs’ website (www.hmrc.gov.uk).

In box 2 in the ‘Other tax reliefs’ section on page Ai 2 of the Additional information pages, enter the total amount of the hmrc-box-1 subscriptions on which you are now claiming relief (but not more than the maximum figure of £1,000,000). Include anyamount for which you received relief by way of an increase in your PAYE code or a reduction of a payment on account. But exclude any amount for which you are claiming relief for the previous year and not the current year 2. In the ‘Any other information’ box, box 19 on page TR 6 of the tax return, you should enter the following details of each investment. * The name of the company invested inEIS-2* The amount on which you are claiming relief for this year * The date of issue of the shares * The name of the HM Revenue & Customs office authorising the issue of the certificate, and their reference number (as shown on the certificate) * If you have subscribed more than £1,000,000 for shares on which relief could be claimed, how you want the relief attributed to them.

You should always check that the company you’re investing in is definitely eligible for EIS or SEIS – and make sure you’re happy with it as an investment. Never invest just for the tax breaks.

You can also invest in a company you know, provided you are not considered to be connected to it by HMRC. Connection means being a partner, employee, director, or having a share of 30 per cent or more.

If you do invest in a company you have come across privately, make sure you buy the shares after the company has been set up, otherwise EIS and SEIS won’t apply.

Investments into an EIS must be retained for a minimum of three years in order to retain the upfront income tax relief. Investments made into EIS qualifying companies, because they are in unquoted companies, are likely to be higher risk than securities listed on the main market of the London Stock Exchange. Investments in shares in unquoted companies are not readily marketable and the timing of any share sales and other such realization cannot be predicted or controlled.

A partial withdrawal of an investment in an approved EIS fund is not permitted. Tax rules and regulations are subject to change, and depend on personal circumstances.