Enterprise Investment Scheme Under Threat

Could changes to EIS tax breaks would see more fledgling businesses cut off from business angel funding.

The Office of Tax Simplification will be reviewing all tax reliefs and allowances ahead of this year’s budget. The Enterprise Investment Scheme will be one of those tax reliefs under the microscope – but as investment through the scheme has slumped, the real question is, will it be missed?

The UK government may be going against public opinion by going easy on bankers bonuses but it still has to find the money from somewhere. The latest issue concerning entrepreneurs and business angel investors alike will be some potential changes to tax relief on schemes such as the EIS.

The EIS and perhaps even Venture Capital Trusts could be abolished if it is decided the government is being a bit too generous with investors.

Last year’s changes to capital gains tax was supposed to have pushed more of those who could afford it towards angel investing and the EIS. They would consider it worth the risk putting some of their money into these schemes whilst helping entrepreneurs get their fledgling businesses off the ground at the same time.

Private Investor Syndicate Hotbed has stepped out and called on the coalition to increase rather than limit (as it does at present) the tax relief for investors in SMEs and certainly not scrap it as part of their review. They feel this would encourage more investment from business angels and other investors into SMEs who will be attracted by the tax breaks on offer.

But increasing the tax breaks is not necessarily the answer if we look at the statistics.

EIS has been around since 1994 but in recent years the number of subscriptions has shown a marked decline.  Although it has to be said that data is only available up to 2008 -09, investment dropped by 29% in this period and it is doubtful if 2009-10 will show any increase. The last time we saw a fall of 29% was during the Dotcom crash. In the previous year (2007-08) £692 million was invested via the EIS so a 29% fall is significant.

The financial crisis certainly had its impact and investor confidence will take time to return. This will be of little help to start-ups seeking capital through EIS. VCTs meanwhile where the tax breaks are less are proving more popular.

Why is this the case? To begin with the rules surrounding investment via the EIS are complex.  It also carries a higher risk than going down the VCT route. One of the main differences between the EIS and VCT  is the requirement for the EIS to raise money for genuinely trading companies with fewer than 50 full-time staff. the size of these companies mean investment is much more risky.

Despite the risk, the tax breaks are generous making it one of the most generous tax advantaged investments out there. But going back to the earlier point the appetite for risk simply hasn’t been there, the EIS is certainly not for the faint-hearted. This means further tax breaks are probably unlikely to attract more investors.

The VCT meanwhile provides a steady stream of income with dividends free of income tax. This steady stream of income is one good reason why VCTs are proving so popular. The EIS needs this kind of clear income stream to attract more investors rather than more tax breaks per se.

If we are to have the private sector driven recovery the coalition is hoping for, then it is clear that they need to find a more effective way to attract investment in SMEs. All the indications are at the moment that the EIS will not survive in its present form and the pressure to reduce tax breaks may be too great to resist. Assuming it survives, this would making the EIS even less appealing in the future.

This would be shame as especially for those businesses hoping to raise funds this way. If it is to be simplified, there needs to be the right balance struck between risk and rewards. Many will be waiting anxiously to see what happens come the next Budget.

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