Tax efficient investing in private companies

Transcription

1 Enterprise Investment Schemes Tax efficient investing in private companies

2 What are Enterprise Investment Schemes? The Enterprise Investment Scheme (EIS) was initiated by the UK Government in 1993 in an attempt to promote funding for small private companies. Since then over 22,900 individual companies have benefited from funding, with over 12.3 billion of funds raised. 1 EIS relief is available by investing in a single company, as well as through funds and discretionary managed services. Although each will have differing risk and diversification characteristics, all are deemed high risk. In compensation, there are a number of tax reliefs. Should I consider investing in EIS? EIS is not a suitable option for everyone, but can be appropriate for experienced investors who are willing to take on a degree of risk within a diversified portfolio. We consider EIS to be a complementary option for investors who: Are Higher Rate (40%) or Additional Rate (45%) Income Tax payers; Wish to supplement their portfolio having fully contributed to both their pension and ISA; Currently own a diversified portfolio and are willing to invest in an inherently risky asset class, with the added incentive of tax breaks; Are resident in the UK and comfortable with a long holding period (in order to gain tax relief). EIS are only suitable for experienced investors It can be particularly attractive for those who: Are looking to reduce Inheritance Tax (IHT) liabilities, or Have a large Capital Gains Tax (CGT) liability. More than 1.6bn flowed into EIS qualified companies in the tax year... an increase of 6% on the previous year. 1 1 Enterprise Investment Scheme Association, January 2016 EIS in a changing pension landscape An increasing number of investors will be affected by pension caps, due to: The reduction in the annual allowance to 40,000 and even lower levels for higher income investors The reduction in the lifetime allowance to 1 million in April 2016 from 1.25 million The implication is that more investors than ever should be thinking about efficiently managing their personal tax liabilities. 2. Risk warning: past performance is not a guide to future performance. The value of investments and the income derived from them can go down as well as up, so you could get back less than you originally invested. Enterprise Investment Schemes should be regarded as higher risk investments, suitable only for experienced investors who are able to withstand losses.

3 Tax advantages of EIS One of the most attractive features of EIS is the range of tax reliefs available to investors: 30% upfront tax relief Investors receive 30% income tax relief on EIS subscriptions, up to a maximum of 1 million per tax year. As this is tax relief, the amount cannot exceed the investor s overall income tax liability for that year. However (unlike Venture Capital Trusts) there is a carryback facility with EIS investment. This allows part or all of the shares to be treated as though they were purchased in the preceding tax year, so investors can count income tax paid in both the previous and current tax years. Deferral of CGT The payment of tax on a capital gain can be deferred if the gain is invested in shares of an EIS-qualifying company. This investment must be made within the period: 1 year before to 3 years after the capital gain. Moreover, CGT becomes due at the rate that applies when the gain is revived (e.g. when the shares are sold). This means that a Higher Rate taxpayer could potentially defer a gain until retirement, at which point, if they were a Basic Rate taxpayer, the gain would be taxed at a lower rate. No CGT on gains Realised capital gains within EIS are exempt from Capital Gains Tax and can be distributed to investors (only where a claim to income tax relief is made). Loss Relief Loss Relief offers a degree of protection: if shares are disposed of at a loss then investors can offset this loss, less any Income Tax relief given. This loss can be offset against income in the current or previous year in which they were disposed of, or can be set off against any capital gains. IHT Free EIS company shares will generally qualify for Business Property Relief (BPR) after two years, and can therefore be exempt from Inheritance Tax. Likewise, they qualify for Replacement Property Relief if purchased using the proceeds from the sale of a business within three years of the sale. Seed EIS (SEIS) SEIS is a further enhancement of EIS tax reliefs designed to offer additional incentives for investing in the smallest (and usually riskiest) companies. Income Tax relief is increased to 50% and CGT Reinvestment Relief allows you to offset 50% of the cost against a capital gain. Unlike EIS, this represents a permanent saving of CGT, not just a deferral. Investors able to offset a gain taxable at 20% could therefore receive total tax relief of up to 60%. Loss Relief would also potentially be available. There is an annual investment limit of 100,000 for SEIS, and slightly different restrictions placed by HMRC on the companies that qualify. 1 1 For details visit: 3.

4 How your money is invested An investor can choose to invest in a single EIS company directly, through an EIS fund or discretionary managed service Single Company This represents the highest risk and requires the time and ability to analyse each proposition carefully. To claim tax relief investors must have an EIS Certificate (typically an EIS3) from the company invested in. EIS Fund 1 An EIS fund will invest on behalf of the investor in a number of qualifying companies, pooling funds raised in order to gain diversification benefits. The investors themselves are still the owner of the shares, and can therefore claim income tax relief. Discretionary Service A discretionary manager identifies EIS qualifying companies to invest in. Each investor's portfolio may differ dependent on the current pipeline of opportuntiies. Typically, there is a higher minimum investment than in an EIS fund. What investments are eligible? In order to qualify for these tax benefits, investments must be made into EIS qualifying opportunities. 1 Qualifying criteria are defined and periodically revised by HMRC. They include restrictions on the size of the company (including number of employees and gross assets) and the trade carried out. 2 A recent example of an excluded trade is renewable energy generation. This follows a number of years during which the industry has grown rapidly, supported by a range of Government subsidies including EIS. It now attracts a significant amount of mainstream funding and HMRC has removed it from the scheme. 1 Although HMRC refer to these types of EIS scheme as funds, they are not to be confused with mutual funds or collective investment schemes. Each investor in an EIS fund will own a proportion of the underlying company shares directly (rather than owning shares or units in a fund). 2 For details visit: EIS Crowdfunding Crowdfunding sites are a source of numerous EIS investment propositions. These can look very enticing but there are a number of serious downsides. When you invest through a fund or discretionary service you are relying on the manager to carry out a thorough investigation of each proposal, to negotiate hard in terms of the price of the shares and, usually, to appoint a director to keep a careful watch on developments. In contrast, the crowdfunding site is acting in a transactional role, being remunerated largely by the amount of money raised for each deal and with little or no financial interest in their ultimate success. 4. Risk warning: past performance is not a guide to future performance. The value of investments and the income derived from them can go down as well as up, so you could get back less than you originally invested. Enterprise Investment Schemes should be regarded as higher risk investments, suitable only for experienced investors who are able to withstand losses.

5 Key risks of EIS All investments involve risk, but EIS investments are shares in unlisted companies and are classified by the Financial Conduct Authority (FCA) as Non Readily Realisable Securities. In this case there are some specific risks that investors should understand before making any decision to invest: Your capital is at risk The value of shares can go down as well as up, so you may not get back as much as you originally invested. Early-stage private companies are an inherently risky asset class, and many EIS investments fail completely, returning nothing at all to investors. The date of investment for tax purposes can be uncertain when you invest This will either be the date the shares are issued, or from the date the qualifying trade starts, if later. If you invest through a fund or a discretionary service, then you are relying on the manager to find a suitable opportunity. For this reason, the date of investment for tax purposes may be uncertain at the point of commitment, and can be considerably after investing. If you sell your holding early, you will lose the tax relief In order to benefit from income tax relief, EIS shares must be held for a minimum of three years from the date of investment for tax purposes. It could be difficult to sell your holding Shares in unlisted, private companies are typically difficult to sell or value. It can therefore be difficult to predict when, and at what value, an investment manager may achieve an exit. EIS shares are not usually traded on an exchange, so there is no secondary market in place. They are deemed illiquid investment vehicles. The length of investment may significantly exceed the minimum three year holding period. If EIS status is withdrawn, you will lose the tax relief Following an investment, the continued availability of EIS reliefs depends on compliance with the requirements of the EIS legislation by both the investor and investee company. Money invested will not be eligible for EIS relief unless used within two years. Where an investor or an EIS qualifying company ceases to maintain EIS status in relation to any individual investment, this could result in the loss of some or all of the available reliefs in relation to that investment. Costs of investing can be high The charging and fee structure of EIS is typically complex, and often difficult to decipher. In the majority of cases, there will be an initial charge applied on investment, which will vary per provider but will be significantly in excess of what an investor may pay for an open-ended investment. In addition most will charge an annual management fee and performance fee, which can be as high as 20%. On top of this EIS fund managers may also charge arrangement, exit and monitoring fees which should be taken into account prior to investment. Tax rules may change Rates of tax, tax benefits and allowances described in this guide are based on current legislation and HM Revenue & Customs (HMRC) practice. These may change from time to time and it cannot be guaranteed that investments that initially qualify for relief will continue to do so throughout the life of the investment. What is Advanced Assurance? HMRC will offer an opinion as to whether an investment would qualify for EIS tax relief, called Advanced Assurance. If the business is subsequently carried on as described, the company can apply after a given period (normally four months after commencing trade) for permission to issue a qualifying certificate to investors. We strongly recommend that EIS investments are only made into companies which have secured an Advanced Assurance. 5.

6 Capital preservation... or growth? There are two main investment strategies followed by EIS funds or discretionary managed services. The following pages provide some recent examples: Capital Preservation EIS These are deemed to be at the lower end of the EIS risk spectrum. Their primary focus is on limiting capital losses and relying on the initial tax relief to generate most of the return. In addition, these EIS strategies will have a more predictable exit time frame, typically soon after the minimum 3-year holding period. Capital Growth EIS These all share the goal of producing a return on invested capital. As with any investment, those that target a higher level of capital gain will typically be taking on a higher degree of risk. These investments will often aim for an exit time frame of 4-7 years, but there can be no certainty about this. EIS EXAMPLE 1 - CAPITAL PRESERVATION The Ark a contemporary adaptation of the Noah s Ark story Great Point Media's Select Television Production EIS Fund invests into new, EIS-qualifying production companies. The investments provide capital to cover the cost of producing drama series and TV movies with international appeal. Each EIS company works with a team of experienced producers, who oversee all aspects of production to ensure successful delivery to end buyers, who include the likes of the BBC, ITV and NBC Universal. In the case of The Ark, the script had been originally been commissioned by the BBC. They committed 1.3m for a 90 minute TV movie, but the ambition for the production budget was 2.1m. The EIS company, together with the producers, negotiated a US presale worth 300,000 and an additional UK tax credit worth another 300,000. They also closed a deal for international distribution, which valued the remaining rights at 500,000. Prior to starting any filming, the production had therefore secured sales and income on 90% of the cost ( 1.3m + 300k + 300k = 1.9m). The majority of this was contractually payable on delivery of the show. The balance of funding ( 200k) was to be recouped from future international sales, which were valued at well above this. The EIS company raised and funded the entire production budget, which was filmed in the UK and Morocco. The show was successfully delivered to buyers, and international sales are sufficient to put the show into profit. The EIS company and producers continue to own future income streams from the show. Risk warning: past performance is not a guide to future performance. The value of investments and the income derived from them can go down as well as up, so you could get back less than you originally invested. Enterprise Investment Schemes should be regarded as higher risk investments, suitable only for experienced investors who are able to withstand losses. 6.

7 EIS EXAMPLE 2 - CAPITAL GROWTH Backing proven operators within the sector There is often a misconception that EIS funds invest in start-up, early stage companies. The Seneca EIS will typically invest in mature, established and profitable companies, predominantly providing later stage capital Degrees was Starbucks first franchisee globally. They opened their first store in February 2013 and had 13 stores prior to their first EIS investment. This is a classic example of an established company looking for new funding to expand its operations. The directors have substantial experience, with a track record in food franchise businesses including Domino s Pizza, Burger King, Costa Coffee and KFC, and the company has been allocated a significant developmental territory by Starbucks for its next phase of expansion, including Oxfordshire, Berkshire, Surrey, Hampshire, Wiltshire etc as well as 23 boroughs within the Greater London area. EIS EXAMPLE 3 - CAPITAL GROWTH An early-stage technology venture Downing's EIS fund specialises in early-stage tech startups. Twizoo is an app that gives users live information about restaurants and bars, based on Twitter sentiment analysis, in place of online reviews. There is a growing lack of trust in online review services such as TripAdvisor. Users believe these products can be gamed and provide out-of-date information. Twizoo allows you to see what people are tweeting about their experience at bars and restaurants in realtime. They do this by buying tweets from the Twitter "Firehose" and analysing them. As well as their own app, Twizoo can be hosted within 3rd party websites and apps. Twizoo launched in London in September Downing's Fund invested in April 2015, and they have since scaled up their operations and the technology underlying them to expand their offering across the US. They are now operating in 14 cities globally, and have also developed other strategic avenues, for example in licensing access to their data for an annual fee. Since launch, Twizoo s big data machine has analysed over 1 million tweets. The app has been downloaded over 20,000 times and has a highly engaged Monthly Active User base of around 10,000 Londoners. 7.

8 Case studies: EIS in practice The following case studies illustrate how the tax advantages offered by EIS can work in practice: CASE STUDY 1: Benefit from 30% Income Tax Relief Income Tax relief means that EIS shares can be sold for less than they were originally bought, and still generate an overall gain. Consider the following example where Ben makes a single EIS investment of 100,000. He sells this for 80,000 after 3 years. Including the initial tax relief, his investment represents an overall gain of 10,000. Ben's investment in a single EIS EIS investment 100,000 Income tax 30% 30,000 Net cost 70,000 Realisation amount 80,000 Gain/loss 10,000 CASE STUDY 2: Loss Relief takes the sting out of failures Unsuccessful EIS & SEIS investments are eligible for Loss Relief, whilst the winners incur no Capital Gains Tax. Consequently a portfolio of winners and losers can produce a better return than a single EIS with the same overall return. Compare Ben's example above with Alfie's below. Alfie invests the same amount into a portfolio of five EIS companies. Two of these become worthless, two repay the original gross cost and one turns a profit, repaying double the gross cost. While Alfie's overall investment is the same as Ben's, and his net realisation amount is also the same, due to Loss Relief he achieves an overall gain of 22,600 more than twice as much as Ben. Alfie's investment in a portfolio of 5 EIS companies Co. 1 Co. 2 Co. 3 Co. 4 Co. 5 Total EIS investments 20,000 20,000 20,000 20,000 20, ,000 Income tax 30% 6,000 6,000 6,000 6,000 6,000 30,000 Net cost 14,000 14,000 14,000 14,000 14,000 70,000 Realisation amount ,000 20,000 40,000 80,000 Loss 45% 6,300 6, ,600 Gain/loss 7,700 7,700 6,000 6,000 26,000 22,600 CASE STUDY 3: Reduce Inheritance Tax liabilities Business and Replacement Property Relief can make EIS investments exempt from IHT. 8. Francis recently sold his publishing company for 500,000 and retired. As a company owner, the value of his shares were exempt from IHT under the Business Property Relief exemption. But now he has sold them the value falls within his estate. Francis has over 1 million in other assets, bringing him well over the IHT threshold of 325,000. This means that the proceeds from his sale would be taxed at 40% on death. Francis is happy to reinvest the money he received for the business. He opts for an Enterprise Investment Scheme fund to spread his risk across several companies. Providing the money he received from selling his business is invested within three years he will qualify for Replacement Property Relief. The value of the shares will then remain outside his estate, saving him 200,000 in IHT.

9 CASE STUDY 4: Reducing Capital Gains Tax liabilities The reduction in the top rate of CGT to 20% from April 2016 offers a tempting opportunity for people who have paid tax at 28% within the past three years. In July 2014 Keith sold a large holding realising a gain of 100,000. As he had already used his Annual Exemption, the whole amount was subject to Capital Gains Tax (CGT) at the highest rate. He therefore paid 28,000 to HMRC via his annual self-assessment. His adviser now tells him that the rate of Capital Gains Tax has reduced from 28% to 20% (and from 18% to 10% for basic rate taxpayers). He can take advantage of the reduction by investing the profit from selling his holding into an Enterprise Investment Scheme (EIS). Keith invests 100,000 into an EIS. Provided he holds the shares for the whole of the three year minimum holding period he will receive the following tax benefits: Income Tax relief at 30% - the net cost of investing 100,000 is 70,000; CGT deferral his 28,000 CGT payment is refunded by HMRC; Tax-free gains any further gains he makes on the investment are free of CGT; Loss Relief if his investment loses money he can offset this against Income Tax; Business Property Relief after holding the shares for two years his investment becomes exempt from Inheritance Tax. Because Income Tax relief and CGT Deferral are granted as soon as the money is invested, the net cost to Keith for investing 100,000 is 42,000. Keith's EIS investment and CGT deferral EIS investment 100,000 Income Tax 30% 30,000 CGT 28% 28,000 Net cost 42,000 EIS investments need to be held for three years to retain all the tax benefits. In addition, the timing of EIS exits can be difficult to predict as they are illiquid investments. But in this case Keith is able to sell his holding after the three year holding period ends. On selling, his deferred capital gain is revived, but it is now subject to the new lower CGT rate of 20%, i.e. he has saved 8,000. In the event of Keith s EIS investment returning less than his net 70,000 investment, he can claim Loss Relief at his highest tax rate. In Keith s case this is 45%. The table below shows the total return to Keith based on different amounts realised. Deferral relief is unlimited and can be claimed by subscribing for EIS shares three years after first making the gain, or one year before it. Once Keith has claimed deferral relief he can roll the gain into subsequent EIS investments to postpone the date at which the CGT bill is payable. In the event of Keith dying whilst holding the EIS investment the CGT would not be payable. If the EIS shares had been held for two years there would not be any Inheritance Tax to pay either. Scenario 1 Scenario 2 Scenario 3 Scenario 4 Net cost 42,000 42,000 42,000 42,000 EIS investment 100, , , ,000 Realisation amount 0 50, , ,000 Loss 45% 31,500 9, Deferred CGT 20% 20,000 20,000 20,000 20,000 Gain/loss 30,500 3,000 38,000 88,000 Please note: These case studies assume that the investors' marginal rate of tax at the time of realisation is 45%. The comparisons may be even more favourable if SEIS relief is obtained. However, there is no guarantee that any of the investments will increase in value, or return anything to investors at all. These examples are provided for general illustrative purposes only. If you have any questions about EIS in relation to your individual circumstances, then we strongly recommend you contact a professional financial adviser. EQ Investors provides a full range of financial and tax planning services and can advise on the suitability of EIS investments. Please call us on to speak to one of our qualified financial advisers. 9.

10 Introducing EQ EQ is an award-winning boutique wealth manager with over 60 staff, based in the City of London. We act for private clients, small companies and charities. Our aim is to be the best, not the biggest. Our ethos is based around putting clients first. We are proud to be one of the first UK B Corporations, an internationally recognised standard for companies that believe in using business as a force for good. investors The EQ research approach The EQ research team conducts a high level review on the wider EIS universe of funds and discretionary managed services, and then completes in-depth quantitative and qualitative analysis on a select panel. EQ does not review individual EIS offers as we consider them to be extremely risky. Investment strategy We ensure that there is a clearly defined risk/ return objective, and an investment process in place to achieve this. This includes evaluating the investment policy and structure, the type of investments made, and the expected composition of the portfolio. This allows us to gain an understanding of the portfolio construction and any diversification benefits. It is crucial that an EIS manager has a strong pipeline of investment opportunities. We analyse fundraises from previous tax years and subsequent investment activity. This is coupled with our assessment of the manager's ability to generate new investment ideas, enabling us to make a judgement about EQ research reports and due diligence the ability of the EIS manager to find appropriate opportunities that are in line with the mandate. Management team We will assess the length of relevant management experience, as well as the quality, structure and depth of resources within the team. We also seek evidence of the manager s commitment to both the firm and the EIS. Track record A key determinant of success is the ability of the manager to exit an investment, which we analyse through various quantitative measures such as Internal Rate of Return (a measure of investment return), alongside other metrics. 10.

11 Benefit from professional financial advice If you are considering investing in EIS then we strongly recommend that you contact a professional financial adviser. EQ Investors is a Chartered Financial Planning firm. We are authorised and regulated by the Financial Conduct Authority, and offer a full range of financial and tax planning services, including advice on the suitability of EIS investments. How to invest in EIS EIS schemes are classified by the FCA as Non Readily Realisable Securities and can only be promoted to investors who seek regulated advice, are classified as High Net Worth or Sophisticated Investors, or are prepared to certify that they will invest less than 10% of their net investable assets in such securities. A shortlist of EIS opportunities is published on our website as part of our holistic financial advice service. If you are interested to find out more about how EIS could complement your investment portfolio, then please contact us for further information: eis@eqinvestors.co.uk eqinvestors.co.uk/investing/eis Important information This document is intended for information purposes only and does not create any legally binding obligations on the part of EQ Investors Limited. Nothing in this document should be regarded as constituting legal, taxation, investment, or other advice and prospective investors are advised to seek financial advice before contemplating any investment. This document and the information contained in it are not intended for publication or distribution to persons outside the United Kingdom. The information in this brochure relates to tax efficient investment funds which are not suitable for everyone and it is important that any potential investor fully understands the risks involved. Enterprise Investment Schemes typically invest in small, newly-formed companies which by their nature will tend to have a higher risk profile than large established companies. The tax reliefs available under current legislation are both complex and subject to change. Although all the information contained in this brochure has been compiled from sources believed to be reliable, its accuracy and completeness cannot be guaranteed. The brochure provides an overview and is necessarily selective and therefore does not purport to provide a comprehensive statement. 11.

12 Aiming to be the best, not the biggest Next steps: For further information please contact us: View current EIS offers online: eqinvestors.co.uk/investing/eis This document has been issued to provide investors with general information about Enterprise Investment Schemes. It does not constitute a personal recommendation in any way whatsoever. Enterprise Investment Schemes should be regarded as higher risk investments, suitable only for experienced investors who are able to withstand losses. EQ Investors, Centennium House, 100 Lower Thames Street, London EC3R 6DL EQ Investors EQ Investors Limited ('EQ') is authorised and regulated by the Financial Conduct Authority. Company number Registered address: One America Square, Crosswall, London EC3N 2SG EQ/0516/223