EIS and Inheritance Tax
Introduction
Although Inheritance tax benefits are not specifically part of the EIS legislation, EIS companies generally qualify as “Relevant Business Property”. If you own Relevant Business Property which you die, your executors are normally able to claim “Business Relief” which used to be called Business Property Relief. After an ownership period of 2 years, EIS companies would generally qualify as Relevant Business Property.
Business Relief gives relief for assets qualifying as Relevant Business Property against Inheritance Tax. Relief is available at 100% relief for unlisted companies. Other assets such as controlling holdings of listed companies, or plant and machinery will still qualify as Relevant Business Property but the rate of relief is lower. You can find more details of what qualifies for Business Relief here: http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM25022.htm
What happens when the EIS exits and the investment returns to cash?
Cash does not qualify as Relevant Business Property and from the moment a binding contract for sale exists over the shares, they will cease to qualify for Business Relief, however, do not despair, there is another relief available called Replacement Property Relief.
Replacement Property Relief is available when you reinvest the proceeds of the sale of Relevant Business Property.
Replacement Property Relief
If you reinvest the proceeds of the sale of Relevant Business Property, you may be able to obtain Replacement Property Relief. The following link helps in determining whether a shareholding qualifies for Replacement Property Relief: http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM25312.htm
There are a couple of dos and don’ts:
1. HMRC expects you to invest all of the sale proceeds in Replacement Property, so don’t be tempted to hold back some of the funds to replace that Kitchen or buy a new car!! Paying fees associated with reinvestment should be fine
2. Taking a portfolio approach makes sense, because you will end up with a larger number of smaller holdings which means that you can reinvest some complete investments and choose not to invest other holdings.
What if the client dies before the 2 year ownership qualifying period has passed
If an investor dies before the expiry of the 2 year holding period after investing in EIS the investments will not qualify for Business Relief and as such the holding will be subject to Inheritance, however, there may still be a tax saving:
The Probate Value may well be lower than the investment amount. This is particularly likely in the case of an Early Stage investment or an SEIS investment where the valuation could be £0. There are anti avoidance provisions to counter any death bed planning.
If the value of the investment is written down, but the investment is subsequently sold for a profit, depending on how long after death the sales takes place, then the probate value may be adjusted to the sale price, however this is unlikely if the eventual sale takes place more than 3 years after death.
The beneficiary will probably be subject to CGT on the sale with the acquisition price being the probate value which means that the rate of tax may be reduced to 28% or less and deferred until the eventual sale of the asset.