March is approaching, traditionally the month in which about half of all Enterprise Investment Scheme (EIS) business is written. But this year there will be a big difference.
New rules, announced by Chancellor Philip Hammond in his Autumn Budget, are likely to have worked their way through the Parliamentary process by mid-March, with the result that a significant number of investments will no longer qualify for EIS.
The investor will face reduced capacity in terms of supply and may be tempted to react by rushing into any opportunities that remain open. This temptation must be firmly resisted.
In this instance, HM Revenue & Customs (HMRC) seems to have potentially gained some significant ground in its long-running war with the tax avoidance industry, which HMRC believes has hijacked the EIS tax reliefs, diverting money away from genuine growth businesses and into capital preservation schemes.
Mr Hammond announced a new weapon in HMRC’s defence armoury: a new principle-based test that will be used to screen out asset-backed schemes thought to breach the spirit of EIS.
This year, the new rules will probably come into effect in early March, removing asset-backed investments and leaving a void for investors who traditionally leave their tax planning to the last minute.
The annual bun fight is likely to mean more investors will be disappointed this year.
In the long run, of course, the market will adjust, and produce more of the growth-orientated companies that the Chancellor wants to encourage. But it will not have had time to do so by the end of next month.
That means a lot of people are going to be left high and dry, and if your clients want to invest in EIS this tax year, they will need to act quickly.
The important thing to remember is that it is possible to have your EIS investment treated as though it was made in the previous tax year using EIS’s really useful facility, ‘carry back’. It may not be critical to get fully invested before the end of the tax year.
Here is a quick refresher on how the carry back provisions of the EIS operate: Carry back is a hugely valuable aspect of the scheme. EIS investors can claim 30% of the value of their investment against income tax.
Why timing is important for VCT/EIS investment
As the name suggests, carry back allows some or all of the investment to be transposed and set against the tax bill for the previous year.
It may be that your client needs to carry back their investment because they experienced a peak in income last year but frequently, investing post tax year end and carrying back gets tax relief just as quickly as if you invest in the current year, except that you have more investment choice.
There are lots of clients who need to use more than one year’s income tax in order to make an EIS investment, particularly those who are attempting to manage a large capital gain.
Obviously, someone needing to fully carry back must be invested before the 5 April. But critically they will only need to be invested up to the amount needed to offset against the previous year’s tax.
Ideally investors should be committing their money to a portfolio and allowing the manager six to eight months to find the right investments for them.
This way some investment will be made before the 5 April which can be carried back to the 2016-17 tax year and then the remainder will be made over summer.
Some of these can be carried-back to the 2017-18 tax year and offset against the tax bill which is due in January 2019. It just moves forward a year.
But let us be clear about one thing. Inconvenient though the new rules may be in the short term, the EIS regime is changing for the better.
There are some great EIS investments out there that have no need of asset backing. Investors ought to be enthused by the changed EIS landscape, not fearful of it. But investors, and their advisers, need to be prepared for what lies immediately ahead.
Going ‘all in’: The Autumn Budget represents a huge step up for EIS
To recap, about half of all EIS schemes from the previous year will no longer qualify because capital protected EIS will cease to qualify from sometime in March, therefore there will be limited investment opportunities from March onwards.
This will mean that investors who must be fully invested may not be able to appropriately diversify their investments and will therefore take on more risk.