Tax rules aimed at urging entrepreneurs to reinvest their chargeable gains in another business have changed why they might plough cash into an Enterprise Investment Scheme (EIS).
How entrepreneurs decide to take their gains revolves around the tax breaks offered by Entrepreneur’s Relief and how capital gains are taxed by EIS.
From December 2014, chargeable gains reinvested in an EIS retain a tax break allowing Entrepreneur’s Relief to be applied when they are eventually sold.
Entrepreneur’s Relief is a special capital gains tax rate of 10%.
The new rules open up several tax planning opportunities for investors who have sold businesses.
No reinvestment limit
Entrepreneurs can defer any gain from the past 36 months by rolling their profits into an EIS or project qualifying for Social Investment Tax Relief (SITR).
The good news is the rules slap no limit on how much money can be reinvested.
This is because EIS tax reliefs do not have to be claimed on the shares, but the shares must meet the qualifying conditions for EIS relief.
Investors have to be careful of another new rule, though, which caps a company raising more than £5 million investment from EIS or SITR in any tax year.
Normally, investors have to hold EIS shares for three years to qualify for income tax and capital gains tax breaks under the scheme.
This is not so for entrepreneurs rolling over gains with an EIS because Entrepreneur’s Relief CGT rates are more advantageous than EIS reliefs, so in most cases, the investor will not claim them.
How the tax break works
That means EIS shares can gradually be disposed of over a number of years in line with the CGT annual exempt amount for the tax year, keeping the tax rate at 10%.
Proving the EIS relief is available on the shares comes from the company providing the investor with the standard EIS3 certificate of eligibility, which includes the paperwork for claiming deferral relief.
The tax break works like this:
An entrepreneur sells a business in March 2015 which leaves him with a taxable chargeable gain of £1.2 million. CGT is due at 10% thanks to the profit qualifying for Entrepreneur’s Relief – which is £120,000.
The tax should be paid by January 31, 2016.
However, investing the £120,000 in an EIS or SITR means the CGT is put off until the disposal of the shares.
Just to clarify a few points raised in Jim’s article:
In Jim’s example, I think the full £1.2m would need to be invested in EIS shares to shelter the £120,000 CGT bill. You get deferral relief at the CGT rate that applies to the gain you are sheltering.
EIS allows you to defer a gain made up to 3 years ago, but the new rule for Entrepreneur’s Relief only applies to gains made since 3rd December 2014.
The cap on a company raising more than £5 million investment from EIS is not new and has been in force since 2012. The limit on SITR is currently much lower, but the government hopes to get EU approval to increase it to £5m later this year.