Attractive tax breaks as part of a diversified investment portfolio

Enterprise Investment Schemes (EISs) are tax-efficient vehicles set up to encourage investment into small, unquoted trading companies. Following the changes announced in various Budgets, the EIS is the only tax-efficient investment offering a capital gains tax deferral. Capital gains tax on the disposal of other assets can be deferred by reinvesting the proceeds in EIS shares.

This relief is slightly different from the basic EIS relief, as there is no limit on the gain that can be reinvested in this way. However, the tax on the original gain will become payable once the EIS investment is sold. The reinvestment can take place up to three years after (or one year before) the original disposal.

The maximum that can be invested into an EIS within the tax year 2010/11 is £500,000 and the same amount can be carried back to the previous year provided the limit in the previous year was not reached. EIS shares are also exempt from capital gains tax once they have been held for three years. Investors in an EIS cannot withdraw their money before the fund has been wound up and are unlikely to find a buyer if they want to sell their stake early as there is no secondary market.

EIS funds fall into two distinct camps: those that wind up after the three years required for investments to be held to qualify (known as ‘planned exit EISs’) and those that carry on until investors agree that a wind-up makes commercial sense. For EIS funds and portfolios, the manager may not be able to invest as quickly as hoped. This may reduce the return on your investment, and the investment may lose its EIS status or tax relief may be delayed.

Investments in smaller companies will generally not be publicly traded or freely marketable and may therefore be difficult to sell. There will be a big difference between the buying price and the selling price of these investments. The price may change quickly and it may go down as well as up.

Investing in an EIS is at the top end of the risk scale, but in return you receive attractive tax breaks. As high-risk investments, EISs may only be suitable for wealthier investors as part of a diversified investment portfolio. The past performance of an EIS is not a reliable indicator of future results and you should not subscribe to an EIS unless you have taken appropriate professional advice.