EIS can form an important part of your clients' estate planning. Simon Ruthers goes through what you need to know.
During a prolonged period of higher personal taxation, advisers need to respond to clients' demands for innovative ways of introducing greater tax-efficiency into their long-term financial plans.
With further reduction in pensions allowances scheduled for 2014/15, this is likely to provide a further opportunity for innovative, non-aggressive tax planning.
An increasing number of advisers have embraced the benefits of incorporating EIS into their recommendations - particularly as this can be a source of incremental fees.
Here are twenty key points to discuss with clients about EIS:
1. 30% income tax relief on investments up to £1m per annum. The income tax relief may be offset against a tax liability arising in the tax year of investment, or ‘carried back' to the previous tax year. Tax relief can be claimed though the PAYE system or through self assessment.
2. The income tax relief reduces any personal tax liability arising on income from all sources, providing a positive cash flow as investors are able to retain a greater proportion of the income they receive. It cannot reduce the income tax to less than zero.
3. Investors get to retain 100% of any growth achieved as capital gains are tax-free.
4. An EIS can be used to defer an unlimited amount of capital gains. As only the gain needs to be reinvested, the original investment can be used for other purposes.
This is an effective way of reducing the tax costs associated with realising investments such as a portfolio of shares, a second home or a buy-to-let property.
As it is possible to defer gains made in the last three years, investors may be able to reclaim any tax already paid. Gains made in the 12 months following investment can also be deferred.
5. By investing in an EIS, the value of the shares will fall outside the investors' estate for IHT purposes after just two years. When combined with the ability to defer capital gains, this makes the EIS an attractive estate planning solution.
6. Should the investment not perform as well as anticipated, any losses (after deduction of the initial income tax relief received) can be offset again income or capital gains (subject to certain conditions).
This means that investors who pay tax at the additional rate can receive back up to 65% of their original investment from income tax relief and loss relief in the event of a total loss.
Table: Summary of tax reliefs
|Income tax relief||No||Up to 60% depending on circumstances||30%||30%|
|Maximum investment qualifying for tax relief per annum||£11,280||Up to £50,000, reducing to £40,000 from 2014/15||£200,000||£1,000,000|
|Ability to claim tax relief for earlier years||No||Yes||No||Yes|
|Tax free income||Yes||No||Yes||Yes|
|Tax free lump sums||Entire fund may be taken tax free||Typically 25% of the fund may be taken tax free||Entire fund may be taken tax free||Entire fund may be taken tax free|
|Treatment on death||Forms part of estate for IHT purposes||Residual fund may be subject to a charge of up to 55%||Forms part of estate for IHT purposes||Tax-free provided the investment has been held for two years.|
|Tax relief available in the event of a loss||No||No||No||Yes|
7. Including an EIS in a clients' portfolio can add valuable diversification at both an investment and product level. Investments in unquoted UK smaller companies are typically uncorrelated with other asset classes.
8. Investors can access a range of investment options, from high growth, early stage, technology businesses developing potentially revolutionary products and services to more traditional businesses operating in established markets.
9. Unlike other wealth management solutions, an EIS will ‘mature' as the manager exits the underlying companies. While investment durations vary, the investor may only need to commit their investment for just over three years.
10. The EIS offers non-contentious tax savings and is supported by the UK government and endorsed by HM Revenue & Customs.
11. Introduced in 1993/94, the EIS has raised over £8.6billion from private investors, benefiting 18,500 companies. The EIS currently raises £600m per annum.
12. An EIS is not a pooled investment. Consequently, investors will hold shares in the EIS-qualifying company. In order to manage risk, most investment managers will adopt a portfolio approach, spreading subscriptions across a number of different companies.
13. Business owners can use EIS to mitigate the personal taxation arising on dividends, offering an effective way of extracting profits from a company.
14. Following the reduction in pension funding limits, an EIS can offer an attractive way of supplementing existing pension savings.
15. In addition to individuals, trustees can benefit from some, and in some instances all, of the tax reliefs provided by EIS.
16. Where an investor has made a gain in the last three years, but has more recent losses, an EIS can be used to ‘leap frog' the earlier gain ahead of the more recent losses. By deferring the earlier gain, an EIS will allow the investor to utilise their more recent losses against the deferred gains when then come into charge when the EIS is sold.
17. Where an investor is eligible for flexible drawdown, having satisfied the minimum income requirement, an EIS can be used to mitigate the income tax arising on any excess income that is taken. The availability of IHT relief makes an EIS an effective solution for those seeking to actively reduce their pension savings in order to avoid the 55% charge that may arise on their death.
18. While an EIS does not typically provide an income, it can be used to reduce the amount of tax payable on income received from other sources, an EIS can provide an alternative income strategy by increasing the level of net income.
19. By using the upfront income tax relief to fund another investment, it is possible to increase the size of an investor's portfolio. For example, an investment of £37,600 into an EIS will provide sufficient tax relief to fully fund a stocks and shares ISA.
20. Individuals who are UK resident, but non-UK domiciled, can bring unremitted foreign income and gains into the UK to invest in an EIS without triggering an immediate tax charge (subject to certain conditions).
As these points illustrate, for the right client, EIS can introduce compelling planning opportunities, enabling clients to diversify their portfolio at both an investment and product level, while also securing a range of generous tax benefits.
Simon Ruthers is manager - private clients at Oxford Capital
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