The pros and cons of knowledge-intensive approved EIS funds

The Enterprise Investment Scheme (EIS) is a government initiative that provides a valuable source of funding to early-stage companies while offering tax benefits to investors. The investors must be in a position to accept the high risks of investing in an EIS. 

An approved EIS knowledge-intensive fund is focused on directing capital to knowledge-intensive companies (KICs), which are defined as companies that consider research and development (R&D) as their main business activity. Following the Treasury’s Autumn Budget 2017, KICs are eligible for more EIS funding compared to other companies.

Investors in approved EIS knowledge-intensive funds are entitled to the same tax reliefs as those in ‘unapproved’ funds (i.e. those that aren’t approved), however there are considerations to take into account before looking to invest. 

At TPO we have decades of experience in advising clients on investing into tax privileged products such as Enterprise Investment Schemes. Please note that this article is intended for professional use only and should not be shared with clients, however if you would like to know more please speak to your usual TPO Adviser. 

Here are some of the pros and cons of investing in EIS knowledge-intensive funds:

PRO: Where a company is a KIC, some of the limits and conditions for companies seeking EIS investment qualification are relaxed:

• The lifetime cap on EIS-eligible investment is £20m (including any investments from all other tax-advantaged VC schemes) as opposed to £12m for other EIS-qualifying companies. 
• The twelve-month investment limit is £10m as opposed to £5m
• The maximum number of full-time equivalent employees is 500 as opposed to 250
• The maximum number of years trading before investment is ten years as opposed to seven years for non-knowledge-intensive EIS qualification. 

So KICs can be more developed than non-KIC EIS qualifying companies. 

CON: However, to be eligible as a KIC, the additional conditions must be met including meeting thresholds of up to 15% of operating costs being spent on research and development or innovation in the last three years. Then, either at least 20% of the company’s staff must be ‘skilled’ by way of higher educational qualifications, or the company must be in the process of creating intellectual property on which its business will be based within the next ten years.

This narrows the investment universe even further than the standard EIS eligibility restrictions. 

CON: A knowledge-intensive approved EIS fund is subject to further rules in addition to those that apply to non-approved EIS funds, i.e. Discretionary Managed Portfolios and the EIS AIF structures. There are maximum timelines for deploying capital from the fund close date, for example. 

EIS funds that aren’t ‘approved’ don’t have the same constraints and therefore have greater flexibility. 

PRO: For income tax purposes, the investments made by knowledge-intensive approved EIS funds are treated as if made in the year in which the fund closed, even if they were actually made in a later year. Investors may also elect to treat some or all of their investments as made in the year prior to that in which the fund closed. 

Since the date of the close is generally fixed, this gives certainty about which tax years the relief can be claimed for.

PRO: The process to claim EIS tax reliefs involves less paperwork than for an ‘unapproved’ EIS fund as investors receive a single EIS5 form for all of the companies they are invested in from the EIS manager with which to make their claim. For ‘unapproved’ EIS funds, investors receive multiple EIS3 forms – one for each individual company they are invested in – direct from the investee companies. 

This means the claim process is less of an administrative burden. 

CON: However, making the actual claim for any tax relief can only be done once the knowledge-intensive approved EIS fund has invested 90% of the subscriptions (the fund has a maximum of 24 months in which to do this) and once the investor has received the EIS5 form. The issuing of the EIS5 form to investors is dependent on every individual investee company submitting an EIS1 form to HMRC and they each have up to two years from the end of the tax year in which the shares were issued or (if later) within two years from the date the company commenced trading to submit this form to HMRC. This triggers HMRC to issue EIS3s to the EIS fund manager, and only when it is in receipt of all relevant EIS3 forms can the EIS fund manager issue the EIS5s to investors. 

In non-approved EIS funds, one or two investee companies that are slow to submit their EIS1 to HMRC do not prevent investors from claiming reliefs available from others that are not. Although the years for which the tax reliefs are available depends entirely on the timing of each investment made by the investment manager on a company-by- company basis. 

If you would like to know more about these types of products please speak to your usual TPO Adviser or request a copy of our brochures; 'Alternative Investing Guide' and 'Tax Planning Strategies for High Income Earners'. 

Please note: This article is intended for professional use only and should not be shared with clients. It is for general information only, does not constitute individual advice and should not be used to inform financial decisions. Investment returns are not guaranteed, and you may get back less than you originally invested. 

The Financial Conduct Authority (FCA) does not regulate tax advice. 

The information in this article is correct as at 18/07/2024