Can EIS be used by a non-income-tax-payer?

Aceace

I have EIS investments made in the last tax year (ending 5th April 2020) but all of my income for that year was covered by allowances, hence no income tax is due. It was the same the previous year.  Obviously I can't use the income tax relief part of EIS, as I haven't paid any, but, I was expecting to be able to claim Capital gains tax relief on any profit I made on those investments in 3 years time. 

I was going to send my EIS certificates to HMRC to prove this future entitlement, but I found the following on the gov.uk website: 

Capital Gains Tax exemption when you sell your investment
If you invest in shares in a company through either EIS, SEIS and SITR, you will not have to pay any Capital Gains Tax when you sell your shares if both the following apply:

• you’ve received Income Tax relief on that investment which has not been reduced or withdrawn at a later date

• you’ve held the shares for the minimum amount of time for the scheme - which will be at least 3 years

This looks like I can't claim the CGT exemption. 
Does anyone know if I'm reading this right,  or has anyone in my position managed to claim the CGT exemption? It seems a bit unfair that not paying income tax would preclude one from qualifying for the CGT exemption. 

Aceace

SELF UPDATE: 

Just in case this helps others in the same position as me, I got the following answer from the HMRC helpline. Note that the operative checked with an inspector before answering. 

The fact that I didn't "receive" Income Tax Relief (due to not having sufficient income) is immaterial. It is the fact that I was "entitled" to claim Income Tax Relief and that entitlement wasn't withdrawn that matters. So, as long as I hold the shares for 3 years before disposing of them, I will be entitled to Disposal Relief (I.e. no capital gains tax) at the point of disposal.

In short, the quote in the OP from HMRC website is misleading. 

FURTHER UPDATE: 

The HMRC operative has just called me back to say that his advice was incorrect and that I would NOT qualify for CGT Relief on disposal. F**k!

mostwelcome

You're right. 
It's an odd quirk, this, but yes if you don't / can't claim EIS income tax relief, you also can't claim CGT relief.
Note, though, that your EIS income tax relief is a bit flexible on date and (depending on when the shares are actually allotted, which is / will be on your EIS3 certificate) can be 'carried back' to a previous tax year if this helps you claim the relief.

bowlhead99

Aceace 

FURTHER UPDATE: 
The HMRC operative has just called me back to say that his advice was incorrect and that I would NOT qualify for CGT Relief on disposal.

@Aceace
Quotes from the HMRC/gov.uk website are often misleading for edge cases because they don't contain the full 6000 pages of small print UK tax law

If you are eligible for tax relief  (https://www.legislation.gov.uk/ukpga/2007/3/section/157 ) AND you make a claim for income tax relief, you are entitled to an income tax reduction (https://www.legislation.gov.uk/ukpga/2007/3/section/158 ). The reduction might be limited if you are over the £1m relief limit, but otherwise you can take it in full to your income tax computation. However, this may practically result in a reduction of £0 because of the way it works through your tax computation.

Then on disposal, the chargeable gains act (https://www.legislation.gov.uk/ukpga/1992/12/section/150A ) says that on a disposal of the shares after the qualifying period, where an amount of EIS relief is attributable to the shares, and there would (apart from this subsection) be a gain, the gain shall not be a chargeable gain.  But that's subject to 'Subject to subsection (3) below' which you need to look at .

Unfortunately subsection 3 tells you that if you didn't get full relief (e.g. the standard 20% (pre 2008 rates) or 30% (current rates) is an amount 'B', and you only got a tax reduction of some lower amount 'A', then only the percentage A / B of your gain is going to escape being a chargeable gain.

So we could imagine that if you bought £3million of EIS shares in a year and the limit was £1 million, you would only be allowed to get income tax relief on the first third of the shares and when you eventually sell up at a big gain, you can only exclude a third of the gain from being a chargeable gain, which seems fair enough. You or the HRMC call centre person might assume at first glance that someone like you who had a reduction in allowable relief for a different reason (e.g. not having enough tax to pay to be able to make use of the full relief in the year you bought the shares) would be similarly caught. You might assume you're going to come out of it badly because you know your income tax reduction in practice was £0... and £0 over £B, is 0%.

But if you read subsection 3 carefully rather than skimming it, it's describing a situation where (paraphrased):
(a) tax liability was reduced or treated as reduced, and
(b) the reduction A was less than the standard 20 or 30% rate B
*AND* (c), the amount A was not found under section 289A(2)(b) of the Taxes Act 1988 or (as the case may require) is not within paragraph (b) solely by virtue of section 29(2) and (3) of ITA 2007;
then you have to use the A/B method; 

However, the fact that they included point (c) means they are trying to carve out certain cases where A is only the number that it is because of some special case (not because of, for example, you were doing a massive amount of EIS investing over the annual million pound limits and only a fraction of it being allowable). So you should look up the references to find out what special case they are thinking of.

The Income and Corporation Taxes Act 1988 ended up getting superseded in 2007 by the Income Tax Act, but what it used to say at 289A
(https://www.legislation.gov.uk/ukpga/1988/1/section/289A/2006-07-19 ) was:

Form of relief.
(1)Where an individual eligible for relief in respect of any amount subscribed for eligible shares makes a claim, then, subject to the following provisions of this Chapter, the amount of his liability for the year of assessment in which the shares were issued (“the current year”) to income tax on his total income shall be the following amount.
(2)That amount is the amount to which he would be so liable apart from this section less whichever is the smaller of -
(a)an amount equal to tax at the lower rate for the current year on the amount or, as the case may be, the aggregate of the amounts subscribed for eligible shares issued in that year in respect of which he is eligible for relief, and
(b) the amount which reduces his liability to nil.

What they were saying in those rules was: you can have basic rate tax relief on the eligible portion of the shares (this was the old rules when it was basic rate relief, not current rules at 30%...), but if you had only a small amount of tax to pay in the year you bought the shares before looking at your EIS situation, the amount of relief you got was defined by 289A(2)(b), i.e. it would be "the amount which reduced your liability to nil". In your case, the amount of relief that reduced your liability to nil was £0.

If we then go and plug it back into the clause from TCGA section 150A para 3, we remember it said you would be doing the A/B method (the reduction you got, divided by full potential relief) to restrict the CGT savings, only if .... "the amount A was not found under section 289A(2)(b) of the Taxes Act" .  

And in your case , the amount A (the reduction you got) was £0, because it *was* the amount found under 289A(2)(b) of the Taxes Act, because 289A(2)(b) says "the amount which reduces his liability to nil".

Therefore the restriction of needing to do A/B and coming up with 0% does not apply in your case. As long as you were eligible for the relief because of the types of shares they were and who you are in relation to them, and you do make a claim, and the circumstances of the relief aren't withdrawn and you don't sell earlier than the required date... then the fact that the actual income tax relief you got is £zero does not actually mean that the fraction of the gain which can be excluded from being a chargeable gain is zero %.  There is nothing to stop you using the rule 'capital gains from this EIS investment, on which I claimed income tax relief, are not chargeable gains', as set out in s150A. It's "subject to subsection (3) below", but subsection 3 doesn't get in your way, once you chase it through the other legislation.

We are not quite there yet; in reading the text above from TCGA section 150A para 3 and logically trying to follow it through, I'd first gone to the 289A(2)(b)Taxes Act because that's the first place the legislation was sending me to, and it confirmed that you were OK if that was the only reference that needed to be looked at. However, the Taxes Act is superseded (by the Income Tax Act 2007) and so we should check out the other reference to ITA 2007 to make sure it still gives the same result for your purchase, which was more recent than 2007/8 and would be under that Act.  To recap, TCGA section 150A para 3 is saying you need to restrict the CGT relief if, paraphrased:

(a) tax liability was reduced or treated as reduced, and
(b) the reduction A was less than the standard 20 or 30% rate B
*AND* (c), the amount A was not found under section 289A(2)(b) of the Taxes Act 1988 or (as the case may require) is not within paragraph (b) solely by virtue of section 29(2) and (3) of ITA 2007;
then you have to use the A/B method; 

So now we have already seen the Taxes Act bit from paragraph (c) we have to look at what they mean by, "the amount A... is not within paragraph (b) solely by virtue of section 29(2) and (3) of ITA 2007", 

where 'within paragraph (b)' is a reference to this amount A saved on your income tax being lower than standard deduction B.

Section 29 of ITA 2007 is found at https://www.legislation.gov.uk/ukpga/2007/3/section/29 and says the below (para 2 and 3 in bold)

29      Tax reductions: supplementary
(1) This section supplements the provisions about tax reductions in Step 6 of the calculation in section 23.
(2) A tax reduction may be deducted at Step 6 only so far as there is sufficient tax calculated at Step 5 of the calculation from which to deduct it.
(3) In deciding whether there is sufficient tax calculated at Step 5 from which to deduct a tax reduction, tax reductions already deducted at Step 6 must be taken into account.
(4)Subsections (2) and (3) apply in addition to—
(a) sections 36(1) to (5) and (7) and 41 of TIOPA 2010(limits on credit for foreign tax), and
(b) any other provision of the Income Tax Acts that limits the amount of a tax reduction.
(4A)  If the taxpayer is an individual, the total of the tax reductions within subsection (4B) that are deducted at Step 6 must not be greater than A − B where—
       A is the amount of tax calculated at Step 5, and
       B is the total amount of the tax treated under section 414 (gift aid) as deducted from gifts made by the taxpayer in the tax year.
(4B) A tax reduction is within this subsection if it is under—
Chapter 1 of Part 5 (EIS relief),
etc

The key bit for working out your income tax relief is as they explain in (2) and (3) of Section 29 above - when working out your tax bill you can only deduct your tax reduction and save tax "so far as there is sufficient tax calculated at Step 5 of the calculation from which to deduct it", and "In deciding whether there is sufficient tax calculated at Step 5 from which to deduct a tax reduction, tax reductions already deducted at Step 6 must be taken into account."      

In your case, you did not have sufficient tax within the calculation to be able to deduct the reduction offered by EIS relief, so it was wasted. But, the amount of tax saving you got (A) is only less than B (standard 30%) due to the operation of these paragraphs (2) and (3) which are saying you can't have more deduction from your income tax bill than you have capacity within your income tax bill ; i.e. when added to other reliefs, it's not allowed to take your tax liability negative.

Plugging that answer back into TCGA section 150A para 3 , it seems quite fair to say at paragraph (c) that: 

the amount A *was* (rather than, was not) found under section 289A(2)(b) of the Taxes Act 1988, and 

the amount A *is* (rather than, is not) within paragraph (b) solely by virtue of section 29(2) and (3) of ITA 2007;

In conclusion:

- TCGA 150A para 2 says where EIS relief is attributable to the shares, if you held them for long enough your gains should not be chargeable gains unless para 3 applies;

Looking at para 3 in your case, (a) tax liability was reduced or treated as reduced, and (b) the reduction A was less than the standard 30% rate B, but when considering (c), this reduction was solely because you didn't have enough of an income tax bill to benefit from a bigger reduction, not because there was some other reason for your share purchase being ineligible for relief, so no worries.

Bottom line, I think that as long as you make your claim for income tax relief to let HMRC know you've got the shares - even if that process doesn't save you any income tax - and the shares continue to qualify for that income tax relief, your gains from them (if any) won't be chargeable.

The caveat is that I'm not a tax professional and this is not advice. So if the potential tax would be a meaningful amount of money in the context of the cost of advice, buy advice.

"Tax doesn't have to be taxing" is the slogan that won HMRC an advertising industry award in 2005; but actually it can be a bit tricky when you are wondering how some of the less mainstream reliefs actually operate.

Aceace

My statement here is clearly in no way adequate for the amount of time you've spent and detail you've given, but ... Thank you @bowlhead99. Its very very much appreciated. You've given me hope. 

I had given up hope after finding the following statement in HS297 (Guidance

HS297 Enterprise Investment Scheme and Capital Gains Tax (2017)

Updated 6 April 2020) https://www.gov.uk/government/publications/enterprise-investment-scheme-and-capital-gains-tax-hs297-self-assessment-helpsheet/hs297-enterprise-investment-scheme-and-capital-gains-tax-2017

What happens where your Income Tax liability is nil
If you have no liability to Income Tax before taking account of your subscription for EIS shares, you’ll receive no Income Tax relief and any gain on the disposal of the EIS shares will be chargeable. You may be able to use your Capital Gains Tax annual exempt amount (£11,100 for 2016 to 2017) to cover all or part of your gain.

I'm not really sure how this squares with your analysis, or which would take precedence. Any comment? 

Aceace

Thanks for help so far. I now have a, hopefully simpler, follow up question. 

It looks like I'll be in the same position again this tax year,  i.e. I won't have sufficient income to pay any income tax. However, its much more serious this year as I have made a particularly large EIS investment that has the serious potential to grow significantly, so I'm particularly keen to pay some tax for this year in case the excellent analysis by @bowlhead99 above doesn't wash with HMRC. At least this year I still have time to increase my income.

My estimate of my total taxable income this year (before allowances)  is ~£12k. It's approximate because its mostly investment income, which is variable. So I need to increase it by at least £6.5k to ensure that I pay some income tax. (£12.5k personal allowance + £5k Starting Rate for Savings +£1k Personal Savings Allowance = £18.5k - £12k income = £6.5k).

Having been retired for 5 years I don't fancy the idea of actually getting a job. So, I've come up with the following alternative, but I'm not sure if all of it would be allowed, so would appreciate being made aware if there are any holes in this plan. 

I have £6.7k in cash in a Vanguard SIPP (no contributions this year). I could withdraw all of this this year which would generate a tax liability of £5,025 (75% of £6.7k).

I could also add £2,880 to the SIPP this year, wait for the £720 government top up,  then withdraw the total £3.6k to generate an additional £2.7k tax liability. This gives me a total taxable income of roughly £19.7k, which will be enough to pay a little income tax. 

Google failed to assure me whether there would be a problem with both contributing to, and withdrawing from, a SIPP in the same tax year. 

I don't need to worry about losing the SIPP pension savings as I have sufficient final salary pensions to meet my needs once I reach pension age (I'm currently 57).

Dazed_and_C0nfused

There could be several complications, firstly taking 1p (or more) of taxable pension income from a DC fund means you are permanently limited to contributing £4k/year.

As you are not working you are currently limited to £3.6k anyway but something which may be relevant.

Also this just doesn't make sense,

I have £6.7k in cash in a Vanguard SIPP (no contributions this year). I could withdraw all of this this year which would generate a tax liability of £5,025 (75% of £6.7k).

Income is taxed in a very specific order so it is unlikely this would generate any liability on its own (or with the extra £2.7k) but it may make other income liable to tax.

But you really need to explain exactly what taxable income you will have in 2020:21 for anyone to understand this better.  Normally this is split into non savings non dividend income (such as the taxable pension withdrawals), interest and finally dividends.

Aceace

Thanks for replying.  I'm ok with limiting my future pension contributions to £3.6k as I don't intend to work again,  so will be limited to this anyway. 

Perhaps I worded my SIPP explanation badly. I should have said it generates a "potential" tax liability, by pushing my total taxable income over the £18.5k allowances.

My pension income will be £5k.
My expected income from interest is £7k.
I've ignored dividend income as I expect it to be below the £2k allowance. 

Dazed_and_C0nfused

Aceace said:

Thanks for replying.  I'm ok with limiting my future pension contributions to £3.6k as I don't intend to work again,  so will be limited to this anyway. 

Perhaps I worded my SIPP explanation badly. I should have said it generates a "potential" tax liability, by pushing my total taxable income over the £18.5k allowances.

My pension income will be £5k.
My expected income from interest is £7k.
I've ignored dividend income as I expect it to be below the £2k allowance. 

Unfortunately tax just doesn't work like that.  You cannot simply ignore taxable income and there is no "allowance" for dividends.

Based on what you have posted you would have sufficient income for it to be taxed.  But only at one of the 0% tax rates so no actual tax to pay.

Pension £5,000
Interest £7,000
Dividends £2,000
Total taxable income £14,000
Less Personal Allowance £12,500*
Income to be taxed £1,500
£1,500 dividends taxed at 0% = £0.00

*if your Personal Allowance is only £11,250 then you be liable on £2,750 but still no tax to pay as the savings starter rate band would come into play.

If you add £2,700 additional pension income then the calculation would be,
Pension £7,700

Interest £7,000
Dividends £2,000
Total taxable income £16,700
Less Personal Allowance £12,500
Income to be taxed £4,200
£2,200 interest taxed at 0% = £0.00
£2,000 dividends taxed at 0% = £0.00

And with a reduced Personal Allowance of £11,250 it would be,

Pension £7,700

Interest £7,000

Dividends £2,000

Total taxable income £16,700

Less Personal Allowance £11,250

Income to be taxed £5,450
£3,450 interest taxed at 0% = £0.00

£2,000 dividends taxed at 0% = £0.00

Aceace

Dazed_and_C0nfused said:

Aceace said:

Thanks for replying.  I'm ok with limiting my future pension contributions to £3.6k as I don't intend to work again,  so will be limited to this anyway. 

Perhaps I worded my SIPP explanation badly. I should have said it generates a "potential" tax liability, by pushing my total taxable income over the £18.5k allowances.

My pension income will be £5k.
My expected income from interest is £7k.
I've ignored dividend income as I expect it to be below the £2k allowance. 

Unfortunately tax just doesn't work like that.  You cannot simply ignore taxable income and there is no "allowance" for dividends.

Based on what you have posted you would have sufficient income for it to be taxed.  But only at one of the 0% tax rates so no actual tax to pay.

Pension £5,000
Interest £7,000
Dividends £2,000
Total taxable income £14,000
Less Personal Allowance £12,500*
Income to be taxed £1,500
£1,500 dividends taxed at 0% = £0.00

*if your Personal Allowance is only £11,250 then you be liable on £2,750 but still no tax to pay as the savings starter rate band would come into play.

If you add £2,700 additional pension income then the calculation would be,
Pension £7,700

Interest £7,000
Dividends £2,000
Total taxable income £16,700
Less Personal Allowance £12,500
Income to be taxed £4,200
£2,200 interest taxed at 0% = £0.00
£2,000 dividends taxed at 0% = £0.00

And with a reduced Personal Allowance of £11,250 it would be,

Pension £7,700

Interest £7,000

Dividends £2,000

Total taxable income £16,700

Less Personal Allowance £11,250

Income to be taxed £5,450
£3,450 interest taxed at 0% = £0.00

£2,000 dividends taxed at 0% = £0.00

Thanks again for taking the time to reply. It is appreciated. 

Sorry if I'm using the wrong terminology. I got the term "dividend allowance" from the government website here. 

It looks like you may have misunderstood my pension income (totally my fault I'm sure as I have very little experience in these matters), so I'll try to clarify. 

My personal allowance is £12.5k.
My guaranteed pension income £5k.
My expected interest income £7k.
My expected dividend income £1.1k.

My belief, and you have confirmed, is that this won't be sufficient to make me liable to pay some income tax. I want to be liable to pay some income tax so that I can claim EIS income tax relief, which would then enable me to claim EIS disposal relief to avoid paying capital gains tax on eventual disposal of the EIS shares (notwithstanding that I may be able to persuade HMRC that I am entitled to this relief anyway as detailed by bowlhead99 above). Again, sorry if I've got some of these terms wrong but hopefully you get my drift.

So, my plan, which is the part I'm unsure about the validity of, is to add to my SIPP and then cash it in to generate further taxable pension income.

I have £6.7k in cash in a Vanguard SIPP (no contributions so far this year).
I plan to add £2,880 to the SIPP this year, wait for the £720 government top up,  then withdraw the total £10.3k to generate an additional £7.725k of taxable income. I believe this would be sufficient to allow me to use my EIS investment to claim income relief. 

My questions are: 

1. Am I allowed to add to my SIPP and cash it all in in the same tax year? 
2. Would this extra income generate a non-zero income tax liability allowing me to use the EIS income relief to bring it back to zero? 
3. An additional question: would I be able to make similar SIPP contributions in future tax years? 

bowlhead99

Some of the confusion was probably because you were talking about taking £5025 of pension income (and potentially £2.7k more) and then gave an example of your current £12k income which included £5k pension income in it; it may have been assumed that those were the same two ~£5ks, with the balance of the original £12k you'd been telling us about made up of dividends or something.

Anyway what it sounds like is:
You have £5k pension guaranteed as it stands;
You can create another ~£5k of income by cashing in your current £6.5k worth of pension pot (just use a nice round £5k to keep the maths easy as you might lose some to charges etc);
You can create another £2.7k of pension by creating and then cashing in another £3600 of pension from a £2880 contribution;
Your pensions income (£5k plus the optional £7.7k) would be more income than your personal allowance, by a couple of hundred pounds, so would need to pay a small amount of tax at basic rate on that;
As you've got some earned income in excess of your personal allowance you would only have £4.8k of remaining 'starter rate for savings income' at 0%;
You would have £1k of 'personal savings allowance' at 0%;
And you'd have about £1.2k of interest income at basic rate;
The dividend income would all be taxed at 0% because it's within that 'dividend allowance' ; that terminology is what they call it on that website or in 'marketing', similar to the 'personal savings allowance' ... but technically although they refer to it in layman terms as an allowance, both the dividend one and the interest one are simply bands of income taxed at 0%; it still counts as income and the differentiation of the concepts (income taxed at 0%, vs income falling within an allowance and not subject to tax) may be relevant for people who are pushing on into higher tax bands etc. 

Anyway as you can see, if you take all that pension there is some tax to pay on your pension and some tax to pay on the interest. So you would become a taxpayer again but could get out of paying all of that tax by using a deduction from EIS relief, VCT relief etc etc (being wary that you might have to repay the relief if the investment ceased to qualify or you sold it early).  On the specific questions:

Am I allowed to add to my SIPP and cash it all in in the same tax year
Yes, no rules against it. 

As a practical point, I don't think Vanguard has much in the way of drawdown options, if anything, as they plan to launch the 'withdrawal' side of the product later, so were only marketing it as a scheme to accumulate pension pots rather than withdraw from them, saying 'watch thus space' for other services. You could transfer it to someone else's product - e.g. Hargreaves Lansdown, who currently have no charges on admin or withdrawals (e.g. as a drawdown or UFPLS)

Would this extra income generate a non-zero income tax liability allowing me to use the EIS income relief to bring it back to zero? 
Yes as illustrated above you would have enough income to pay tax and then could use other mechanisms to reduce your tax bill (e.g. EIS relief)

An additional question: would I be able to make similar SIPP contributions in future tax years? 

Yes. The pension providers may get a bit annoyed with you if you create and close a new pension each year. As you don't need quite as much as all the income from a new pension this year to turn you into a taxpayer, you could consider keeping the pension open and only taking part of it.