Timing is of the essence in tax-efficient investment, this is almost a mantra especially in the case of Enterprise Investment Scheme (EIS).
Changes to EIS as a result of Phillip Hammond’s Autumn Budget have fundamentally altered the previously-established investment timetable. The majority advisers have not realised what this means for them and their clients.
The Budget introduced changes to ensure that EIS funds were channelled into genuine growth companies and not, in the Chancellor’s words “low-risk investments, known as capital preservation schemes”.
EIS are all the better for this change, which has returned them to their original purpose of providing an incentive for investors to take positions in exciting young companies. A side effect has been to change the investment timetable completely.
EIS investment has two essential components. First the allotment of shares in the investee company and second the issue of the EIS3 tax certificate which allows the holder to claim tax relief.
With capital preservation EIS, although the allotment of shares was reasonably predictable and swift, it took a long time to get an EIS3 certificate issued. Now, these positions have been reversed.
The reason is this: previously, in the run up to the tax year end, an industrial scale production line of off-the-shelf capital-preservation companies would be created specifically to take advantage of the EIS rules. Advisers would have little difficulty finding homes for their clients’ money as these companies were specially created to meet the demand.
Because these companies were often freshly minted, they would need to establish 4 months trading history before applying to HMRC to issue EIS3 certificates. Add into this a couple of months pre- trading and a 3-month-plus delay by HMRC in meeting the demand for certificates and you often found a 12-18 months delay before tax relief can be claimed.
Since the Budget changes, the industrial production line for capital preservation EIS has been switched off and that gravy train is stuck in the station. The new focus on growth stocks means that investors are likely to be putting their money into trading businesses, which means that the investee company can apply immediately to HMRC to have the EIS issued.
What takes the time now is the finding of companies to invest in in the first place. This can be a lengthy process as it involves conducting detailed due diligence and often watching the company over a period of time.
On the whole, advisers are not aware that this has upended the EIS investment timeline and still think that EIS is essentially a “tax season” investment. I have heard many advisers say that they don’t start to think about these recommendations until later in the year.
Under the capital preservation regime, a lot of product was saved up to accommodate advisers in the ‘tax season’, and it was not unusual for 45 per cent or more of annual business to be conducted in February and March.
This won’t work anymore, for the simple reason that the need to select and scrutinise growth investments means it can take six months for a fund to invest even a modest portfolio.
From a timing point of view, if an investor waits until February or March they will most probably not be fully invested by the tax year end.
Using carry back it is possible to have investments treated as though they were invested in the previous year and therefore, the period May to October is a great time to invest. There are a few added bonuses to investing in the spring and early summer:
Firstly, if investors pay their tax through self-assessment, they can elect to reduce the July Payment on account, providing that they expect to have the certificates in time for the following January tax filing deadline. An added is benefit is reduced payments on account the following year as well.
Secondly, employees who are paid via PAYE can apply to have their notice of coding adjusted for the remainder of the tax year as soon as they are in receipt of the tax certificates.
Thirdly, investing in the summer means that there is a strong chance of receiving the EIS3 certificates in time for the January deadline.
Finally the summer is a time when there is less money chasing more investment opportunities making it an investors market.
Be warned, there will be a dearth of investment opportunities in the run in to the tax year end next year. Indeed, last year there were some clients who failed to get allocated in time despite starting to invest in November or December.
In this new growth environment, Advisers need to be prioritising their tax efficient investment recommendations earlier and not wait until the traditional tax year end bun fight.
The term ‘sell in May’ does not apply here!