Investing in a business can be one of the most tax efficient ways to grow your capital. This activity can take many forms, from starting your own company with a view to making an eventual exit, to investing in someone else’s business. The latter is especially popular amongst higher rate taxpayers seeking to reduce their income tax liability. Each of the different options comes with different qualifying conditions and offers different pros and cons. This article explains the main differences to be aware of and how to qualify.
Investors’ Relief (IR)
Introduced in 2016, this is aimed at encouraging investment into entrepreneurial activities. Although many of the rules are aligned to the Enterprise Investment Scheme (EIS) rules, it is less restrictive than EIS and in some ways similar to Entrepreneurs’ Relief (ER) in that it enables the investor to benefit from the same 10% capital gains tax rate as a qualifying entrepreneur is able to when they sell the shares in their company, with the same £10 million lifetime limit to the relief. This makes IR very attractive for individuals who may have already used their £10 million ER entitlement. Like EIS however, an investor is not permitted to be an employee of the company and the shares must be held for a minimum of 3 years.
Enterprise Investment Scheme (EIS)
This is aimed at high net worth individuals wishing to secure additional income tax relief for investing in early stage businesses within qualifying trades. Prior approval from HMRC is required to ensure the company involved is EIS approved and that the tax relief is available. Investors are not permitted to have a ‘connection’ with the company in which they invest and must not receive any payments in return for investing. Up to 30% tax relief can be claimed, provided the shares are held, and remain qualifying, for a minimum of 3 years. Capital gains tax on other gains can be rolled over if gains are re-invested in a EIS qualifying company within certain time limits. Trades that are excluded from EIS include hotels and property development or investment companies.
Entrepreneurs’ Relief (ER)
Originally introduced to replace business taper relief, ER entitles an entrepreneur to pay just 10% capital gains tax on the sale of company shares. The qualifying criteria are that at least a 5% shareholding is owned in a UK trading company conducting a qualifying trade. Employees who have acquired shares through an approved EMI share scheme can benefit from the 10% tax rate without having to hold a minimum 5% holding. As with EIS, trades involving property and other investment vehicles are restricted. Each individual has a lifetime Entrepreneurs’ Relief allowance of £10 million and a couple who jointly own a company each have £10 million provided they each qualify.
At a glance comparison of ER, IR and EIS
- Investment amount: ER – No limit; IR – No limit; EIS – Max of £1m per year
- Tax relief on investment: ER – None; IR – None; EIS – 30%
- CGT rate: ER – 10% up to £10m; IR – 10% up to £10m; EIS – None
- Min holding period for shares: ER – 1 year; IR – 3 years; EIS – 3 years
- Restrictions on director/owner involvement: ER – Necessary to qualify; IR – Business angels or unremunerated director only; EIS – Business angels or unremunerated director only
- Level of ownership required: ER – Min 5% shareholding; IR – No restriction; EIS – Max 30% shareholding.
If you run your own business or are considering making investments and would like advice on capital gains tax, please contact Lesley Stalker by emailing partners@rjp.co.uk