EIS guide

45 SUITABILITY Suitability Suitability is an important topic, and what follows are guidelines to bear in mind when considering whether an EIS investment is a suitable investment for a client. Investments into smaller, unquoted companies are high risk and advisers need to spend time thinking about suitability and documenting the thought process in suitability reports when recommending an EIS. Attitude to risk In general, a client for whom an EIS is likely to be a suitable investment has a high tolerance for risk. Where succession planning is relevant, you should also make the client’s intended heirs aware of the risks involved. EIS investments should be considered as carrying the potential of a capital loss for investors. While this should never be a 100% capital loss when the income tax relief is taken into account (assuming it isn’t withdrawn for some reason), clients should be comfortable taking on this risk with the funds they have allocated to EIS investing. FCA classification A single company EIS investment is typically classified by the FCA as a non-readily realisable security (NRRS), unless the investee company is listed on the Alternative Investment Market or NEX Exchange. An adviser who wants to advise their client to invest into an NRRS requires retail permissions to advise on shares. An EIS fund will either be structured as a discretionary portfolio service or as an alternative investment fund. From the investor’s perspective, these structures may have few material differences - the EIS manager will allocate the investor into a portfolio of EIS-qualifying companies. However, for a discretionary portfolio service, the MiFID investment manager will have to consider the specific needs of the investor, while for an alternative investment fund the alternative investment fund manager will not. With either structure, the adviser will have to determine whether an investment into unlisted securities is suitable for their client. Further information on Legal and Regulatory Status is also set out on page 54. The FCA rules on suitability reports require that advisers: √√ Specify the client’s demands and needs, √√ Explain why the firm has concluded that the recommended transaction is suitable for the client, having regard to the information provided by the client, √√ Explain any possible disadvantages of the transaction for the client. Tax capacity Although tax benefits alone should not be the primary driver for the investment, a prospective investor would likely be someone who is in a position to take advantage of the tax reliefs available from investing in EIS. Therefore, if they are planning to purchase newly-issued shares in an EIS-qualifying company, the client should have (or expect to incur in the near future) an income tax liability, a CGT bill, or an estate with a potential IHT liability (to the extent that BR was a consideration for the investment). The client should also be aware that the tax reliefs can be withdrawn and that the shares might, at some point in the future, be worth less than they initially cost, although, where the reliefs are retained, income tax relief and loss relief can limit losses. The client should also be aware that if they are looking to acquire EIS shares in a company which hasn’t yet started to trade, the three-year holding period does not start until the company starts its trade (which could be a number of months after investment). This could therefore delay the receipt of income tax relief and mean that shares have to be held for a longer period. Capacity for loss If a loss of the capital earmarked for EIS investment would have a materially detrimental effect on the client’s standard of living, then they should be advised against investing in EIS shares. Attitude to risk and capacity for loss should be assessed independently of each other. They * However, where an investor disposes of an asset that would give rise to a capital gain, and reinvests all or part of the gain in shares which qualify for SEIS income tax relief, 50% of the gain reinvested will be exempt from CGT. ISA Pension VCT EIS SEIS ANNUAL MAX £20,000 £40,000 £200,000 £1m (£2m for KICs) £100,000 LIFETIME MAX x £1.055m x x x INCOME TAX RELIEF x √ 30% 30% 50% POTENTIAL FOR LOSS RELIEF x x x √ √ POTENTIAL FOR IHT RELIEF x only available for AIM it depends x √ √ CGT FREE GROWTH √ √ √ √ √ CGT DEFERRAL x x x √ x* TAX TREATMENT OF INCOME No further tax to pay for higher rate taxpayers; Interest: tax-free. No further tax to pay for higher rate taxpayers; Interest: tax-free - but only in roll-up phase; Payouts from annuity or drawdown will be taxable. Dividends within £200k annual maximum subscription: tax-free. Dividends: taxable. Dividends: taxable. TAX-FREE LUMP SUM √ 25% √ √ √ TAX WRAPPER OPTIONS SUMMARY