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Naturally, we all hope that our early-stage investments are successful. Yet even with the best preparation, losses sometimes happen. With the Enterprise Investment Scheme (EIS), the good news is that the “loss relief” mechanism helps to protect some of your capital when this occurs. Yet how does it work exactly? How can it be used effectively? Below, we explore these matters in more detail. We hope you enjoy this content. To find out more about our EIS pipeline and other opportunities, visit our portfolio page here. For enquiries regarding our latest projects and funding, you can reach us via:
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What is EIS loss relief?
Investing in early-stage companies is inherently riskier than investing in large, publicly-traded stocks. Cashflow may still be unstable and the business may be yet to turn a consistent profit. EIS companies tend to be further along their lifecycle due to the qualifying criteria (e.g. no more than 250 employees and gross assets under £15m). This can be the stage where the highest growth potential is on offer – yet also greater risk.
EIS loss relief helps investors to offset losses from EIS investments against their tax bill. This is done in a relatively straightforward manner via Self Assessment, filling in the SA108 form which accompanies the main SA100 form. The value of the loss relief will stand between 20% and 45% depending on the rate of tax you pay. Relief must be claimed within a specified time limit and you can offset against your income tax or capital gains tax (CGT) bill.
EIS loss relief: an example
Suppose you make a £100,000 investment into an EIS-qualifying company. At the outset, you get 30% income tax relief, resulting in a net cash outlay of £70,000. If the investment later came to a £0 net loss, then you could claim loss relief via Self Assessment. As an additional rate taxpayer, you can claim back 45% of the net cash outlay – i.e. £31,500. Your net loss, therefore, is £38,500 which is 38.5% of your initial £100,000 outlay. Whilst still painful, this is much better than a total loss and gives the investor at least some degree of portfolio protection.
How can I use EIS loss relief effectively?
Ideally, the best way to use EIS loss relief is to not need to use it at all! Yet, in reality, some of your EIS investments may fail or underperform despite your due diligence. Here, EIS loss relief is no replacement for diversification and other good investor practice. As mentioned in one of our previous articles, venture returns follow a power distribution which means that, as you build up more EIS holdings, your chances of losing money start to fall. For instance, a portfolio of 5 early-stage companies has a 40% chance of delivering negative returns, yet the investor with between 100-150 startups has very low odds of losing money.
This is one reason why, at Bure Valley Group, we believe that building up your own portfolio of EIS companies is usually better for diversification than relying on EIS funds (which tend to focus on 5-15 holdings). When an appropriately-sized early-stage portfolio is constructed using strong due diligence, this reduces the risk of an investor needing to fall back on EIS loss relief. If this is eventually necessary, the incidence will hopefully be low.
At this point, if an EIS investment is underperforming the investor needs to ask the age-old question: “When do I cut my losses?” EIS loss relief can allow you to remain invested for longer by reducing your real losses. Yet even with this mechanism available, it may not be worth waiting until your outlay reaches £0 before deciding to withdraw. This decision is not easy and multiple factors should be considered (e.g. with a financial/investment adviser) beforehand. In particular, has the leadership changed? Has the company consistently failed to achieve key milestones and metrics? Has the wider market landscape deteriorated against the company, making it very unlikely to succeed?
It is worth noting that EIS loss relief can play a role in wider tax planning – for instance, to lower future inheritance tax (IHT) on your estate. In 2023-24, IHT stands at 40% on the value of an individual’s estate over £325,000. Various strategies can be used, of course, to mitigate IHT like combining with your deceased spouse’s unused IHT allowance and passing your family home down to “direct descendants”. Yet EIS can also be useful for estate planning since EIS shares are free from IHT if held for at least 2 years. If, after your death, the EIS shares are sold at a £0 loss, then the 38.5% negative return (assuming you were a 45% taxpayer) is still less than the 40% that you may have otherwise paid in IHT if the shares did not qualify for EIS and had been held in a general investment account. These are complex areas of tax planning and it is wise to not make big decisions about your estate on your own. Speak with a financial adviser to get the best information and guidance in light of your financial goals and situation.
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