In another look at the world of UK-based Enterprise Investment Trusts, this article, by John Williams, managing partner at Kuber Ventures, looks at aspects of the tax benefits and features of the EIS model.

Editor’s note: In another look at the world of UK-based Enterprise Investment Schemes, this article, by John Williams, managing partner at Kuber Ventures, looks at aspects of the tax benefits and features of the EIS model. The article comes ahead of the government's 20 March budget in the UK. As ever, while this publication is pleased to share these views with readers it does not necessarily endorse all the opinions expressed in this article.

As the tax year-end approaches, the attention of advisors and their clients will focus on tax-efficient investments and, where appropriate, making the most of the allowances available.

Enterprise Investment Schemes are one way of doing this, as they offer significant tax incentives to encourage individuals to invest in small UK companies, something that the government is keen to support as an alternative to funding from the high street banks.

While the EIS structure is becoming increasingly popular and well known, one commonly overlooked opportunity at this time of year is the “carry back” facility that allows investors to treat all or part of the cost of shares acquired in one tax year as though they had been acquired in the preceding tax year.

Essentially this facility is the tax equivalent of Marty McFly’s DeLorean in the movie Back to the Future, a way of taking a step back in time and allowing relief to be given against the income tax liability of the preceding year rather than against the tax year in which those shares were acquired.

For example, when investing in an Enterprise Investment Scheme, income tax relief can be given at 30 per cent on the amount invested up to a maximum of £1 million. This provides a maximum tax reduction in any one year of £300,000 providing the investor has sufficient income tax liability to cover it.

By making an investment in EIS before 6 April 2013, this tax relief can be carried back and treated as if it was invested in the 2011/12 tax year. This provides a useful tax planning opportunity to reclaim from HM Revenue & Customs a proportion of the tax liability paid in respect of 2011/12.

However, there are a couple of important issues to be aware of. First, the carry back investment will be subject to the rules prevailing in the preceding tax year and in 2011/12 the maximum investment amount was £500,000.

Secondly, in order to be able to carry back to 2011/12, the investment in the EIS-qualifying companies must be made on or before 5 April 2013, which is different from the date monies are actually invested in an EIS discretionary portfolio. The shares must also be held for a minimum period of three years or income tax relief will be withdrawn.

Hand in hand

Despite this, carry back and EIS investments go hand in hand perfectly, not only in helping to manage tax liability, but also by helping the economy climb out of its economic slump.

On a broader note, EIS also offers other forms of tax relief. One of the most popular ways to invest in EIS is via discretionary portfolios, where there is no fund structure and where the investor is the beneficial owner of each underlying share. The investor therefore receives tax free gains where shares are disposed of at a profit and loss relief for those disposed of at a loss - essentially a win-win scenario for the investor.

Another relief can be found in capital gains tax exemption, which states that if income tax relief has been received on the cost of the shares and the shares are disposed of after they have been held for the minimum period of three years, any gain is exempt from CGT.

Furthermore, if shares are disposed of at a loss, an election can be made that the amount of loss, less any tax relief given, be set against income of the year in which they were disposed of, or any income of the previous year, instead of being offset against any capital gains.

Finally, the payment of tax on a capital gain can be deferred where the gain is invested in shares of an EIS-qualifying company. The gain can arise from the disposal of any asset, but the investment must be made within the period one year before or three years after the gain arose. So, for example, for any individuals with gains arising in April 2010, monies would need to be invested in EIS-qualifying companies within a matter of weeks.

So while many investors have heard and understood the benefits of EIS investing, very few understand the financial planning opportunities that it can offer. As the tax year end approaches and investors are reminded to engage more actively with their wealth managers, maybe now is the chance to remind them of the opportunities available to them, not just for this tax year, but also for the one before.