Capital gains made on the disposal of any kind of asset can be deferred by reinvestment in EIS companies. The investment must be in newly issued ordinary shares, subscribed for in cash.
Gains that can be deferred are those made on the disposal (not deemed disposal) of a chargeable asset not more than three years before, nor more than one year after, the EIS investment is made.
The maximum gain that can be deferred is not limited to the £1m applicable to EIS income tax relief. It is possible to invest more than that and get deferral relief on the total investment. In addition, deferral relief is available where the investor does not meet the strict conditions of being unconnected with the EIS company. They can, for instance, be the sole shareholder.
Deferral relief is not therefore dependent on income tax relief.
The deferred gains will become taxable if:
- the EIS shares are sold or disposed of other than to a spouse.
- the EIS shares are exchanged for non-qualifying shares.
- the EIS shares cease to be eligible shares (e.g. conversion to deferred or preferred shares) within three years of issue or three years of commencement of trade, whichever is the later.
- the investor becomes non-UK resident within three years of issue or three years of commencement of trade, whichever is the later, unless he or she is going to work full-time offshore for three years or less.
- an EIS company ceases to qualify for any reason (e.g. starting a non-qualifying trade) in the three years following the issue of the shares, or in the three years from the commencement of trade, whichever is later.
- the investor receives certain prohibited benefits in the period beginning one year before and ending three years after the issue of the shares or three years after the commencement of trade, whichever is the later. These can include directors’ remuneration, rents, loans or interest, which HMRC regards as excessive. Even a small amount of ‘excessive’ benefit can trigger the whole of the deferred gains although there are de minimis levels. Value can be repaid to the company if it has inadvertently been withdrawn.
The deferred gains will not be taxed on death, or if the shares are transferred to a spouse (though in that case they are taxable on the spouse). Death washes out the deferred gain completely. The death of a life tenant, however, will lead to the crystallisation of a deferred gain when a trust has invested in an EIS company.
An inter-spouse gift means that a later disposal by the donee spouse triggers the deferred gain, which is chargeable on the donee.
Gains that do crystallise can be deferred again by a further EIS investment. It is important to note that there is a risk that the EIS investment may turn out badly, involving loss of funds but still leaving tax to pay on the deferred gains. There may, however, be CGT loss relief available on the EIS investment to soften the blow.
The interaction with Entrepreneurs’ Relief (ER)
In general, investors can potentially benefit both from the deferral of gains which can be reinvested under EIS and from ER on those same deferred gains when they come back into charge.
In overview, ER provides a lower capital gains tax rate of 10% (as compared to a standard rate of 20%) on gains arising when disposing of qualifying assets. ER is subject to a lifetime limit for individual investors of £10m.
CGT deferral relief is not available for SEIS investments.
Subject to certain conditions, however, gains realised on any asset disposed of in 2012/13 and reinvested in SEIS qualifying shares in that tax year (or the next using the carry back facility), where the SEIS shares are held for at least three years from the date of issue, are exempt from CGT. Transfers to spouses or civil partners do not prejudice this holding period requirement. This exemption was extended to gains realised in 2013/14 and subsequent years, but relief is capped at 50% of the qualifying SEIS investment.
CGT deferral relief is not available for VCT investments.