Mercia EIS Funds

Mercia mention in FT Adviser Guide to Enterprise Investment Schemes (EIS)

Our MD recently contributed to the FT Adviser’s Guide to Enterprise Investment Schemes, where readers can learn about tax advantages of EIS, EIS charges and more. Here in full are Mercia Fund Management’s answers to important questions on EIS.

What is an EIS?
Enterprise Investment Scheme, and its recently introduced cousin Seed EIS (SEIS) are tax reliefs available solely to private investors and their spouses investing into limited liability businesses in the UK. The spirit of these investments, as tested by HMRC’s subjective test, is to provide investment capital to young (less than two years old for SEIS) and growing (EIS) companies where the tax reliefs are there to commensurate the potential risks associated with investing in small but growing businesses. A summary of the reliefs are: EIS: 30% income tax relief, 28% CGT deferral, loss relief, IHT exempt after two years, and CGT-free returns; SEIS: 50% income tax relief, 14% CGT exemption, loss relief, IHT exempt after two years and CGT-free returns.

What are the pros and cons of an EIS?
In regard to both EIS and SEIS, the pros are:
(i) the exceptional and legitimate tax reliefs available (income tax relief, CGT exemption or deferral, loss relief and Inheritance Tax Relief) which help to offset investment risk whilst enhancing net returns for private investors;
(ii) the UK is a growing hotbed of investment prospects across a range of high growth sectors which require alternative investment channels due to the lack of bank lending to early stage businesses and SMEs;
(iii) the government has committed to maintaining these reliefs as this capital is seen as an important source of investment for businesses (with over £1bn raised in 2012/13 for EIS and SEIS) and tax efficient investment for private investors; and
(iv) private investors, through EIS funds, are able to access a hedged portfolio of stellar business opportunities which would traditionally be the preserve of institutional investors.

The cons include:
(i) young businesses are inherently more risky than established larger businesses (which are outside of the focus of EIS and SEIS)
(ii) investors in EIS can invest up to £1m per annum, however SEIS are limited to making £100k per annum
(iii) dividends generated in businesses are not tax free, and
(iv) tax reliefs are lost if the business is sold in less than three years since the investment was made.

Who should invest in an EIS?
Investors should look at EIS and SEIS on a balanced portfolio basis – treating this as part of their overall investment strategy. EIS and SEIS are for investors who understand long term investment with realisations/returns typically taking anywhere from three to eight years.
Funds typically have more influence in a business than individual private investors, and investors without substantial sums to deploy (i.e. below £100k per annum) should invest via a fund that will protect their interests. Investors seeking to lose or defer CGT liability will find these structures attractive, coupled with the fact that in the first one-two years of the investment they will get 30-64% of their investment back in tax reliefs.

What are the tax advantages for EIS?
For both EIS and SEIS, the tax reliefs are tremendous. For EIS: 30% income tax relief, 28% CGT deferral, loss relief, IHT exempt after two years, and CGT-free returns); and for SEIS: 50% income tax relief, 14% CGT exemption, loss relief, IHT exempt after two years and CGT-free returns.

How do the tax advantages relate to performance?
Tax advantages relate to performance as if the investment is held for at least three years, the capital gains are tax free. The high level of income tax and CGT reliefs, coupled with loss relief, means there is a large downside protection provided in the event that the investment fails. Therefore, the tax advantages of EIS and SEIS have the greatest impact to overall performance when applied to a capital growth focused investment strategy; compared with a low risk, low return strategy which primarily benefits from the initial income tax relief without fully utilising the advantages of CGT exemption on investment returns and loss relief.

What are the long term tax planning uses for an EIS?
Both SEIS and EIS are long term investments and investors need to be prepared to wait 3-8 years for investment returns. Tax efficient investing is becoming an ever more important aspect of holistic financial planning and EIS is a key component of this. EIS offers medium to long-term investors the prospect of significant capital growth across a diversified portfolio, alongside enhanced risk mitigation through the available tax advantages.

How can I make sure I get the best EIS for my client?
The things to look for are:
(i) a fund manager experienced in operating in this space as the EIS regulatory landscape is not simple and the associated tax reliefs are important and can easily be lost if the investor is uncertain of what they are doing;
(ii) a focussed manager with an investment team reflective of the fund’s investment focus;
(iii) a manager with a track record in reporting regularly and accurately to its investors ideally with online access; and
(iv) ’real risk’ investments – watch out for investment structures working against the spirit of EIS/SEIS – the HMRC are looking at such investments and with the newly introduced subjective test, investors might find themselves having to repay tax benefits many years later.

What are the alternatives to an EIS? What are the pros and cons of the alternatives?
The obvious alternatives to EIS are SEIS and Venture Capital Trusts (VCTs). VCTs do not have the same generous tax breaks as EIS and SEIS and do not offer IHT benefits. However, they do provide limited liquidity for investors and importantly tax-free dividends which could be of particular benefit when looking to generate an additional income to a pension for example. This results in a more modest level of returns but a lower risk profile (as they typically invest in lower risk assets) than EIS/SEIS. There is a growing trend towards SEIS/EIS from VCT due to the substantial tax reliefs now available for SEIS/EIS.

To read the full guide, please visit: