Impact of future tax rules

Introduction

We created these planning scenarios to help advisers create suitable strategies for their clients, including making best use of available tax reliefs. To keep our examples straightforward, we have not the impact of charges or illustrated a range of tax rates that may be relevant to different clients. These examples should not be considered advice, and client recommendations should be based on a comprehensive review of client objectives.

Our examples are designed to illustrate how EIS qualifying investments in general can work as part of a client’s portfolio. For information about our EIS investments, we have detailed product information available here.

Scenario

Chris is in his mid-50s and has been a client for several years. He is a high earner who consistently invests in excess of his annual pension contribution and ISA cap. As a result, he has built a significant portfolio of core investments.

He is keen to add private assets to his portfolio in order to target more significant growth from a non-core addition to his portfolio. He wants to target long term growth, and expects that in doing so he will need to make investments that are illiquid. He is comfortable with this as all of his short and medium term needs are met from his salary and core portfolio. Part of his goal is to target levels of growth and diversification outside listed stocks and funds.

Chris is concerned about the impact of future tax policies on the returns from the investments he plans to make. He wants to support private companies and accepts the increased investment risk that comes with targeting higher returns, but is worried about the risk of changes in tax policy impacting returns from investment. The risk of real returns being diminished by the introduction of a 40% or 45% rate of Capital Gains Tax is causing Chris to consider whether taking incremental investment will feel worthwhile over the next 5 -10 years.

This is of particular importance as Chris intends to make these investments outside of his tax free wrappers.

A solution designed by the Government for retail investors

Chris’s adviser explains the Enterprise Investment Scheme (EIS). EIS is a tax relief the Government introduced more than 30 years ago to encourage investment in early-stage unquoted companies with high growth potential. Qualifying investments are made into the shares of exciting early stage, unquoted UK businesses which have the potential to achieve significant growth, but where due to the early stage in the company’s journey, the risk of failure is also material.

To encourage investment and reflect the risks, investors benefit from a generous range of tax reliefs, which in effect reduce the cost of investment, and boost post tax returns from successful investments.

How it works

• Money is invested into the shares of qualifying companies, to support the business during its early years as it seeks growth. An exit is provided if and when the company reaches a major milestone, such as a sale or listing on a stock exchange. In this way, investors are exposed to the potential for significant capital growth over the exciting early years of a company’s life. This is typically a period of 5-10 years.
• On investment, 30% of the amount invested can be reclaimed against income tax paid in respect of the year of investment, or the previous year. So for a £10,000 investment, £3,000 can be reclaimed.
• In the future, if a successful exit for investors is achieved, the growth in value will be completely free from capital gains tax. With EIS qualifying investments having the potential to grow to be worth multiples of their initial value, receiving proceeds free from 24% Capital Gains Tax (current rate) can result in a significant boost to post-tax returns.
• And if a company fails, assuming the EIS conditions were met up until the time that the company failed, investors are entitled to claim tax relief in respect of the loss suffered (after taking the benefit of income tax relief into account).
• Shares also qualify for Business Relief from IHT. From April 2026, everyone has a £2.5 million Business Relief Allowance. Qualifying shares worth up to £2.5 million can be left free from IHT, saving 40% provided they have been held for at least 2 years when the investor dies. Investments in excess of £2.5 million benefit from an effective 20% IHT saving.

Investors typically create a portfolio of EIS investments, either by self-selecting individual qualifying companies, or by investing in a portfolio designed by a specialist manager with skills and experience in this sector. Investors can potentially benefit from tax relief when any individual portfolio company fails, no matter how well their portfolio is performing overall. This is incredibly powerful. It means that investors typically consider the maximum amount of capital at risk is only 39p of every £1 invested.

A way to invest in relative tax certainty

Chris’s adviser explains that the EIS ‘sunset clause’ has recently been extended until 2035. It was also a feature of the Conservative party manifesto, therefore has cross-party support. In fact, EIS has been supported and extended since its launch 30 years ago – perhaps not surprising given almost half of the UK’s most successful start-up companies received investment through the EIS.

Therefore, while tax rules can and do change, the fact that the sunset clause has so recently been extended for 10 years creates relative certainty for those investors seeking to back UK growth.

Chris’s adviser explains that if CGT rates were to change in the future, from example from 24% to 40%, an EIS investment should continue to benefit from tax free growth. When considering investments with a larger range of outcomes, having clarity of the tax costs impacting real returns can be very important.

An example for Chris

Chris is keen to start investing in a small portfolio of EIS qualifying investments each year. He wanted to invest in private companies with the goal of targeting growth from unlisted shares, and the fact the tax benefits offset a portion of his risk is very attractive. Chris and his adviser consider this a good way to extend his tax-free investments beyond his pension and ISA pots, while also achieving his goal of adding higher risk, diversified assets to his portfolio.

His adviser shows how EIS tax reliefs can work across an illustrative example small portfolio of EIS companies, with upfront tax relief acting to mitigate some of his investment risk, and tax free growth providing another pot of investment capable of growing without being exposed to CGT.

Chris’ adviser reminds him that investments have to be held for at least 3 years in order for EIS relief claimed to be retained. However, as he will be investing into early stage companies with the expectation of holding them as they grow, and where there is no opportunity to exit until the company reaches a major milestone that enables investors to exit, he expects to hold them for more than 3 years.

Chris understands that if a company ceases to qualify within 3 years, relief will be withdrawn.

Chris decides to invest £50,000 into an EIS Fund run by an experienced manager. After initial fees and dealing fees are paid, the balance of his investment is invested equally across 8 EIS companies. In this example, £45,534 is invested into qualifying companies, entitling him to claim £13,660 of income tax relief upfront.

In our example, 3 of the companies fail, meaning that Chris will not receive any proceeds back from these investments. He will be entitled to claim relief against tax for his “effective loss” – the amount he invested in each of these companies after the benefit of the 30% upfront income relief claimed in respect of each has been accounted for. If he chooses to claim this against income tax, it will save him tax at 45%, delivering a further £5,379 tax benefit. After tax relief is taken into account, the amount of capital lost on each failed company is 38.5% of the amount invested into each.

The other 5 companies in our example are successful over the following 8 years, with three returning proceeds that are double their investment amount and two being very successful and delivering ten times the amount invested as proceeds on sale. Chris will benefit from these exits being exempt from Capital Gains Tax – this would otherwise be charged at 24% of the gain on each company, a tax bill of £29,537 in total.

In reality, it is not possible to predict how an early stage company will perform at the time of investment. Investors should expect to experience failures and to be invested over a medium to long timeframe, which they do not control. But for the right investors, the tax reliefs designed to mitigate the impact of some of the risks can be very valuable and present a well structured way to add this interesting and exciting asset class to a portfolio.