Are EISs suitable for your clients?

With the average age of EIS investors falling, are more people finally waking up to the products’ tax benefits?

First of all, for whom is the Enterprise Investment Scheme (EIS) suitable? The EIS has a cocktail of tax benefits and, of course, it is most appropriate for someone who can make use of the maximum tax breaks.

The EIS is effectively the “only place to go” to defer a capital gains tax (CGT) liability, so clients with CGT bills are the number one prospect. If, in addition, they are older and looking to shelter part of their estate from IHT, so much the better.

In fact, combining CGT deferral and IHT is one of the most powerful tax planning tools – effectively killing two taxes with one investment.

There is also income tax relief to be obtained and, following the recent relaxation of the carry-back rules, it is possible to carry income tax relief back to the prior year up to the annual maximum investment limit.

Spreading your EIS investment and applying it to successive income tax years can optimise the benefits, so you and your clients need to do some careful planning.

Risky

While the EIS used to be the province of mainly-elderly people, the stats show that the average age of EIS investors has been going down in recent years. We think this is the result of younger investment professionals waking up to the tax benefits of EIS investing, in particular freedom from CGT when exiting from a successful investment.

The EIS has traditionally been regarded as the riskiest category of investment and assumed, as a single company investment, to be much riskier than a pooled investment fund. But of course that ignores the fact that an EIS portfolio or fund can replicate the spread of a pooled fund – the greater the spread, the lower the risk.

However, not only should the EIS be approached on a portfolio basis, but also it should not, together with similar higher risk investments, represent more than about 5% of a total investment portfolio.

UCIS

There has been a trend toward EIS funds in recent seasons and there is now a debate raging about whether an EIS fund constitutes an Unregulated Collective Investment Scheme (UCIS).

Legal advice varies on this subject, but our current view is that EIS funds are essentially a discretionary portfolio service and are not UCIS.

However, whether the fund is UCIS or not, provided it has an FSA-regulated fund operator, you will be able to promote it to certified high net worth or sophisticated investors or to people who, in your opinion, fall into the COB 4.12 conditions – broadly speaking professionals and professional investors, but including ‘category 2’ individuals (those “for whom the firm has taken reasonable steps to ensure that investment is suitable”).

And this will be the case even if you are a non-MiFID firm, so long as the asset or portfolio manager has the appropriate authorisation from the FSA to permit the receipt of orders in compliance with MiFID.

Finally, EIS offers will vary with regard to the prospectus rules. Many EIS offers are issued as Section 21 offers – in simple terms, this means that the sponsor or promoter takes responsibility for the contents of the offer document.

Alternatively, it might be an offer which is exempt from the prospectus rules – this just means that investors are relying on the directors of the company for all the statements made, which probably makes it riskier if something goes wrong.

As a result of its diverse tax benefits, the EIS can be a suitable investment for many people and are definitely worth considering as part of a diverse portfolio.

Christian Elmes is head of investment promotion and product development at Enterprise Private Equity. Susan Phillips is director general of the EISA.