Income Tax Relief: Everything You Need To Know

Income tax relief is available to individuals investing in certain unlisted companies and social enterprises. The following schemes can help you reduce your income tax are:

  • Enterprise Investment Scheme (EIS)
  • Seed Enterprise Investment Scheme (SEIS)
  • Social Investment Tax Relief (SITR)
  • Venture Capital Trusts (VCT)

EIS and SEIS

A business that meets the Enterprise Investment Scheme (EIS) criteria could attract more investors. Investment into businesses that qualify, attract capital gains tax and income tax relief for the investor.

When the business is less established for the purposes of EIS, it may be eligible for the Seed Enterprise Investment Scheme (SEIS). It is possible that a company qualifying for SEIS will become one that qualifies for EIS. 

There are different qualifying criteria for each scheme and they offer different levels of income tax relief. For example, SEIS investors will receive income tax relief of 50% of the cost of the shares, whilst EIS investors receive income tax relief of 30%.

The following table compares EIS and SEIS for an individual investor:

 EISSEIS
Income tax reduction30% of invested funds50% of invested funds
Order of income tax reductionAfter VCT reliefBefore VCT relief
Deferral reliefDefers a capital gainFor 2013/14 onwards, exempts half the capital gain
Maximum relief investment per investor£1m
£2m if at least £1m of that is invested in knowledge-intensive companies
£100,000
DisposalsGains exempt after three years and losses allowable for offset against gains and incomeGains exempt after three years and losses allowable for offset against gains and income

The following table compares some of the company differences for EIS and SEIS:

 EISSEIS
Maximum investment£5m from all schemes in any twelve-month period;
£12m for all companies;
£20m for knowledge intensive companies.
£150,000
Maximum ageLess than 7 years old when it receives its first investment;
Less than 10 years for knowledge intensive companies
No time limit for follow on funding.
Less than 2 years old and company must not have previously carried on a trade.
Maximum number of full time equivalent employees< 250
< 500 if knowledge intensive company
< 25
DisposalsGains exempt after three years and losses allowable for offset against gainsGains exempt after three years and losses allowable for offset against gains
Balance sheet gross assets limit£15m before and £16m after investment£200,000 before investment
PurposeFor a qualifying tradeFor a new qualifying trade

A knowledge intensive company is one that at the date of the share issue meets an operating cost condition plus an innovation condition and/or a skilled employee condition. 

Operating Cost Conditions:

  1. In any one or more of the three previous years, at least 15% of the relevant operating costs were spent on research, development or innovation OR
  2. In each of the previous three years at least 10% of the relevant operating costs was spent on research, development or innovation.

Innovation Conditions:

  1. The company (or subsidiary within the group) is engaged in intellectual property creation at the date of issue AND
  2. It is reasonable to assume that in 10 years the exploitation of the intellectual property will form the greater part of the company’s business.

Skilled Employee Condition: At least 20% of the full time equivalent employees are skilled employees, which are those with a masters degree or above who are engaged directly in research, development or innovation activities.

SITR

Social Investment Tax Relief (SITR) is designed to help raise money to support the trading activity of a community interest company, community benefit society or charity. The company exists to benefit the community rather than purely shareholders so those seeking returns on investment may be less inclined to invest. It offers investors tax relief on shares they buy or money they lend the enterprise, when the scheme rules are met for at least 3 years.

The maximum annual investment relief that may be claimed is £1m at 30%. Capital gains tax deferral may be obtained at 100% of investment. If shares are sold, gains are exempt from CGT and there is relief available for capital losses against income.

Venture Capital Trusts

Venture Capital Trusts (VCT) invest in small firms to help them grow. The investment is regarded as high risk and should be for the long term. The government offers generous tax reliefs to those investing in VCTs. Tax relief is available to reduce income tax as well as defer CGT.

The maximum annual investment relief that may be claimed on is £200,000 and relief is capped at 30%. Dividends from a VCT are tax free.

CGT deferral may be achieved where an investor, having made a previous gain, invests into a VCT. Furthermore, gains realised on VCTs are exempt from CGT, although shares need to be kept for five years to qualify. Any deferred gain will become chargeable when the VCT investment is sold unless further planning is undertaken.

Additional rate taxpayers earning over £150,000 have their annual pension allowances reduced by £1 for every £2 extra income earned. For those with earnings over £210,000 the annual pension allowance is capped at £10,000. Additional rate taxpayers could use a VCT to complement their pension provision.

 VCTPensionISA
Initial income tax relief30%20-45%No relief
Annual limits£200,000£10,000-40,000£20,000
Lifetime limitsNo limit£1m

No limit
Minimum holding period5 yearsAccessible at 55+None
Ongoing tax benefitsTax free dividends and growth25% tax freeTax free dividends and growth

One strategy could be for regular investments to be made in VCTs thereby reducing a current year income tax liability. If this were undertaken annually, any growth in the first VCT could be realised tax free. With regular annual investments and assuming capital growth, after five years an investor could be in a position to realise tax free investment on a rolling basis.

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