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

bowlhead99

Aceace said:

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? 

In the link you have, there is an interpretation "You may not have to pay Capital Gains Tax on a gain on your disposal of the EIS shares, even if you didn’t receive Income Tax relief in full on all your EIS shares, provided you received some Income Tax relief. In this case, to qualify for Disposal Relief, none of that Income Tax relief must have been withdrawn and the only reason you didn’t receive Income Tax relief in full was that your claim reduced your Income Tax liability to nil."

It's saying that if you do get some income tax relief you are OK, because they won't prorata it for your relief over the full 30% theoretical relief if the only reason you didn't get full relief was having your claim reduced to nil by running out of tax bill.

That 'no prorating if you ran out of tax bill' is consistent with my links earlier. If it's really true that to qualify you do need to have some practical reduction of your income tax bill, rather than simply have made the claim for a deduction you can't use, then you can easily create some income as you saw above, by taking a bit of pension income, and then when you make the claim for income tax relief you will be actually getting some relief, rather than not needing any relief.

From end to end, following the various tax acts through:
In the part of the chargeable gains act which deals with CGT on EIS situations (https://www.legislation.gov.uk/ukpga/1992/12/section/150A ) it's clear that,
"if on any disposal of shares by an individual after the end of the period referred to in ...section 159(2) of ITA 2007 where an amount of EIS relief is attributable to the shares, there would (apart from this subsection) be a gain, the gain shall not be a chargeable gain"

So, the question is, for a non taxpayer, is it true that "an amount of EIS relief is attributable to the shares"   ? 

We know from Part 5, Section 157 of ITA 2007 that you as the investor would meet the criteria to be eligible for EIS relief if you get the shares under certain conditions
(https://www.legislation.gov.uk/ukpga/2007/3/section/157 )

157 Eligibility for EIS relief
(1)An individual (“the investor”) is eligible for EIS relief in respect of an amount subscribed by the investor on the investor's own behalf for an issue of shares in a company (“the issuing company”) if -
(za)the risk-to-capital condition is met (see section 157A),
(a)the shares (“the relevant shares”) are issued to the investor,
(aa)the shares are issued before 6 April 2025,
(b)the investor is a qualifying investor in relation to the relevant shares (see Chapter 2),
(c)the general requirements (including requirements as to the purpose of the issue of shares and the use of money raised) are met in respect of the relevant shares (see Chapter 3), and
(d)the issuing company is a qualifying company in relation to the relevant shares (see Chapter 4).

And we know from Part 5, Section 158 of ITA that as long as you make a claim as an eligible investor, you would be entitled for a tax reduction of 30% (or lower amount if investing over £1m)
https://www.legislation.gov.uk/ukpga/2007/3/section/158

158 Form and amount of EIS relief
(1)If an individual -
(a)is eligible for EIS relief in respect of any amount subscribed for shares, and
(b)makes a claim in respect of all or some of the shares included in the issue,
the individual is entitled to a tax reduction for the tax year in which the shares were issued (“the current year”).This is subject to the provisions of this Part.
(2)The amount of the tax reduction to which the individual is entitled is the amount equal to tax at the EIS rate for the current year on -
(a)the amount or, as the case may be, the sum of the amounts subscribed for shares issued in that year in respect of which the individual is eligible for and claims EIS relief (qualifying shares), or
(b)if less, the allowable amount.
2ZA)The allowable amount is -
(a)if the qualifying shares do not include any KIC shares: £1 million;

So, at face value this sounds like you can claim EIS relief and will be entitled to a tax reduction (whether or not that reduction actually saves you any money or clashes with other reductions and reliefs). The Chargeable Gains Act reference in section 150A which I linked above was saying that 'where an amount of EIS relief is attributable to the shares, there would be a gain, the gain shall not be a chargeable gain'.  So what do they mean by EIS relief being attributable to the shares... what's the definition of 'EIS relief' for this purpose? Do you have to actually save tax?

Well, further down in section 150A, at paragraphs 10A and 11, it says: (https://www.legislation.gov.uk/ukpga/1992/12/section/150A )

(10A) In this section—“EIS relief” means relief under ...  Part 5 of ITA 2007;
(11) ... Part 5 of ITA 2007 (enterprise investment scheme) applies for the purposes of this section to determine whether EIS relief is attributable to any shares and, if so, the amount of EIS relief so attributable;
and “eligible shares”  means ... shares that meet the requirements of section 173(2) of ITA 2007.

It sounds very much like the 'EIS relief', 'attributable to any shares' being referenced in 150A TCGA means the relief offered under Part 5, ITA 2007 section 157 and 158 which were shown above headed up Eligibility for EIS relief and Form and amount of EIS relief, and which explained that someone is entitled to an income tax reduction if they and the shares qualify and they make a claim. In other words, EIS relief offered under Part 5 would be 'attributable to the shares', if the person and the shares qualify for it under Part 5, and claimed it which it sounds like they do and would.

So relief is offered under Part 5 of Income Tax Act, which when claimed results in a 'tax reduction'. The only reason the tax reduction does not act to reduce your tax is that a completely different part of the Income Tax Act (i.e. not Part 5) says you won't be able to make use of the reduction and deduct if from your bill if you don't have enough tax ; as previously linked:

https://www.legislation.gov.uk/ukpga/2007/3/section/23
...Step 5 Add together the amounts of tax calculated at Step 4.
Step 6 Deduct from the amount of tax calculated at Step 5 any tax reductions to which the taxpayer is entitled for the tax year under a provision listed in relation to the taxpayer in section 26.See sections 27 to 29 for further provision about the deduction of those tax reductions.
Step 7 Add to the amount of tax left after Step 6 any amounts of tax for which the taxpayer is liable for the tax year under any provision listed in relation to the taxpayer in section 30. The result is the taxpayer's liability to income tax for the tax year.

https://www.legislation.gov.uk/ukpga/2007/3/section/29

29Tax 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

This doesn't say that EIS relief will be denied and you can't have it. Simply, EIS relief is not something that goes directly into the tax computation at Section 23. Unlike a bunch of other reliefs where you compare them to certain limits and then literally deduct the relief at stage 2 of the calculation, the EIS relief appears to operate to generate a 'reduction' once you put in a successful claim, and then you can only deduct that 'reduction' from whatever you have left at stage 5 if there's enough capacity when considering how much you had at stage 5 and what other relevant reductions you still want to deduct.

If UK tax was straightforward (and not steeped in case law) then it would seem black and white that the gov guidance is a simplification and you can make your claim for EIS relief even if you don't have enough income - and having made a valid claim for those particular shares, you would be able to later sell them CGT-free after the relevant period.  However, perhaps what actually happens is that when you send in the EIS form to claim the relief, some HMRC bod writes back to you and says 'this claim is denied, it's not valid because you don't have enough income', and then you won't be able to access CGT disposal relief.

To me that chance of being 'rejected' seems unlikely, because whether or not a claim is valid is down to the facts and circumstance at the time (was it a valid issue of shares by a qualifying company and you're not a connected person etc, and if it is, you can have a deduction) and not about how much money you eventually earned for the year which determines whether the deduction offered is useful in lowering your tax bill.

Really, your options are
- see a tax professional who has the previous experience (or belief they would be successful in representing the point) of definitely being able to obtain Disposal Relief a few years down the line from here, or

- create a bit of extra income so that you can definitely lodge a claim and 'make use of' some EIS income tax relief on the shares (until you hit the wall of insufficiency of income) so that you know you won't be denied for Disposal Relief.

If you're happy with the latter one, that seems the easiest thing to do ; although to generate enough extra income for 2020/21 without getting a job, may involve moving your pension to a provider that will allow you to draw it out this tax year which will be some sort of admin hassle, compared to not taking the income.

Aceace

Many thanks again @bowlhead99, superb analysis. 

I came to the same conclusion that those were my two options. I've decided to try both. I'm too late to affect my income for last year, so I'll send my EIS claim forms in and see what response I get. These are only relatively small investments, so, even if they do make gains, may well be covered by my CGT allowance. 

For this year I'll try the second option of cashing in my SIPP to try to generate the tax liability. I'm expecting my EIS investment from this year to generate a very substantial gain, so I'm going for belt and braces as far as possible here. Some of the round figure income values I stated are somewhat variable, so can't be known for sure at this point (particularly my P2P interest, though I've tried to estimate this conservatively), so may still have to fallback on the first option again.

I'd be happy to pay a competent tax expert to argue my case if necessary. If they were anywhere near as thorough as yourself I'd be more than happy. Unfortunately, my opinion of IFAs is not good as I've seen the advice that friends have been given that has been truly diabolical. Apologies to any decent IFAs out there, which I'm sure do exist, but I'm just not confident of finding one.

Thanks again, your analysis has been invaluable. 

spider42

A similar issue has already been considered by the courts, in the case R Ames v HMRC [2015] TC04523. I don't think I'm able to post a link, as I'm fairly new here, but if you Google the case, you should be able to find some commentary on it. Mr Ames had income of only £42, but made £50,000 of EIS investments. He didn't make a claim for EIS Income Tax relief, as he didn't need to, because his income was already under the personal allowance. When he came to sell his EIS shares, he made a significant capital gain, and tried to claim EIS disposal relief to exempt his capital gain. HMRC challenged his claim, on the basis that he hadn't claimed Income Tax relief, and HMRC's decision was upheld by the First Tier Tribunal.

The tribunal commented as follows: "It is true that Parliament amended TCGA s150A with the object of allowing investors to obtain the full CGT exemption even where their low income tax liability prevented them making full use of the EIS income tax relief. But when Parliament made this change, it did not detach the CGT exemption from the EIS income tax relief (although it could have solved the problem in that way) but rather retained the same mechanism: there has to be a claim, and the individualʼs income tax must be reduced as a result."

So making a claim on its own is not enough, it is also a requirement that the Income Tax must be reduced. So if there is no reduction in the Income Tax liability, there is no CGT relief either.

However, another interesting point was made in the case, and I think this will help you. The personal allowance is not given automatically. According to the legislation, it must be claimed by the taxpayer. Section 35 of the Income Tax Act 2007 states:

An individual who makes a claim is entitled to a personal allowance of £12,500 for a tax year if the individual meets the requirements of section 56 (residence etc).

So it would be open to you not to claim the personal allowance, to incur an income tax liability on your income, and then claim EIS relief to reduce or eliminate that tax liability. Mr Ames raised this point in his case, and HMRC agreed that this would have been acceptable. However, this argument ultimately did not help him, as he hadn't made a claim for EIS Income Tax relief, and was too late to do so (and HMRC also refused to allow a late claim).

I'm not sure how you would go about not claiming the personal allowance, since in practice HMRC grant it without a claim. There is no box on either the paper tax return or on the SA online filing system to either claim it or not claim it. I would suggest you submit a paper tax return, along with a letter specifically stating that you do not want to claim the personal allowance, but do wish to claim EIS Income Tax relief.

bowlhead99

Aceace said:

I'd be happy to pay a competent tax expert to argue my case if necessary. If they were anywhere near as thorough as yourself I'd be more than happy. Unfortunately, my opinion of IFAs is not good as I've seen the advice that friends have been given that has been truly diabolical. Apologies to any decent IFAs out there, which I'm sure do exist, but I'm just not confident of finding one.

Unfortunately being 'thorough' in looking at written laws isn't sufficient because in a commonlaw jurisdiction such as ours, case law (i.e. what has already been decided in court about something that might seem ambiguous or for or against the 'spirit' or 'intention' of a rule) is important and an integral part of how things are decided.

A tax practitioner (the competent tax expert you mention) would be well placed to consider what's allowable with the help of his database of law and practice and his firm's resources; whereas an independent financial adviser is generally not a member of a tax industry body and is instead regulated by FCA for investment services (investment risk and product suitability etc); he will know that the gov.uk summaries of different things are not as comprehensive as the old HMRC website used to be, but will not necessarily keep a subscription to taxation magazine etc in its place.

The info from @spider42 above is a good pointer to a particular case where the first tier tribunal ruled on the fact that someone with low taxable income (and no income above the personal allowance) had not made an EIS claim and was then barred from getting disposal relief as HMRC wouldn't allow a late claim for the income tax side and the two are linked.

"It was clear that the legislation was only intended to apply where there had been a valid EIS income tax claim. The Income and Corporation Taxes Act 1988, s. 289A(1) (now the Income Tax Act 2007, s. 158(1)) required an income tax relief claim be made and by TCGA 1992, s. 150A(2) that claim effectively passported the shares through to the CGT exemption, so long as the relevant conditions continued to be met. Mr Amesʼ share disposal did not meet those statutory criteria.

Whilst statute did require that the personal allowance be claimed, even if Mr Ames had sufficient income left as a result of not having claimed his personal allowance, EIS relief was not automatic, Mr Ames was still required to have made a timeous claim unless HMRC allowed his late claim."

The tribunal didn't have the power to tell HMRC to allow a late claim, or to tell them to exercise their 'care and management' discretion to allow the gain to be exempt from tax, so the only remedy the claimant had would hav been to seek judicial review at the high court for the perceived unfairness (including the refusal to allow a late claim that was within HMRC's powers to allow).  Effectively the FTT confirmed that the statutory provisions did require an income tax claim in order for the CGT exemption to be available and that there was no scope for reading the provisions differently so as to allow the exemption. 

It was noted in the case that Ames said he hadn't 'claimed' his personal allowance ; HMRCʼs online SA calculation programme had automatically given him a personal allowance and contained no machinery allowing him to leave his £42 of income into charge; as the statute requires that a personal allowance be claimed, and the operation of online SA calculation programme was a unilateral action by HMRC and not a claim, he contended that he still had taxable income after all and so should just get the EIS relief. But that line of thinking went nowhere because he didn't positively make an EIS claim which is something that you definitely need to do, in order to later rely on it for a CGT claim.

The case in question is not quite analogous to your situation because ultimately that person's situation was one in which no EIS claim had been made, whereas I was suggesting you definitely do need to make the claim despite not getting any income tax benefit from making it because the resulting deduction will reduce your tax bill by zero. The claim itself is not prohibited, AFAIK.

Within the tribunal case, they looked at TCGA150A and noted that the paragraph (3) stuff [about restricting the gains exemption to A/B if the tax saving is less than the standard 30%] began  "(a)..an individual's liability to income tax has been reduced..." as the precondition for that subsection. However, I believe that to be a red herring; you do not even need to look at paragraph (3) because the liability to tax hasn't actually been reduced; paragraph (2) is all you need, which says that EIS relief needs to be attributable to the shares, which on following through the other definitions means the shares qualified for relief and the person claimed the relief. That point was not argued against, as it wouldn't have helped the case anyway, because the person didn't claim the relief. So I would be wary of 'you need to get a tax reduction' as being taken as a definitive outcome from the tribunal; ultimately it settled on 'you need to claim the relief', and a late claim for relief wasn't accepted.

In your situation, I think that Spider's suggestion that - if you don't have any taxable income needing relief, just don't claim your personal allowance and then you will have enough income to use the relief - is one that must work as a solution; it's good.

But practically it is probably not as good as your own solution where you don't need to give away your personal allowance. Effectively you get to take income out of your pension tax free because you have your full personal allowance covering most of it and your EIS relief covering the rest of it.  If you don't extract your current Vanguard SIPP money tax free this year (along with the £3600 of extra pension that you'll be creating when making the most of this year's pension contribution allowance) while you have the opportunity, you will probably want to bring it out of the pension wrapper as taxable income in some later year instead, and ultimately may need to pay tax on it, which is not very efficient.  If the EIS relief offered this year could shelter your pension-wrapped money from tax now as you bring it out of the pension, that's great.

Of course, if you bring your Vanguard SIPP money (and the new £3600) out of its current hiding place of a pension wrapper, it will be back in your bank account and income generated on it (e.g. interest or dividends) will no longer be safe from income tax - unless you can stuff it into an ISA wrapper or more EIS, VCT etc.  So you may prefer to keep it in the pension if you are planning to grow it, and maybe just let someone inherit it from you in the future. But if you want it back as spending money it would be a good idea to 'create extra income' for yourself by drawing it out of the pension and then cover any income tax on that extra income by making the EIS claim that you need to make anyway.

spider42

bowlhead99 said:

So I would be wary of 'you need to get a tax reduction' as being taken as a definitive outcome from the tribunal; ultimately it settled on 'you need to claim the relief', and a late claim for relief wasn't accepted.

I'm sorry, but it is 100% definitive that you need to also get a tax reduction. The original First Tier Tribunal decision was appealed to the Upper Tribunal, and they upheld the original decision. The comments from the appeal make it very clear that not only must an EIS Income Tax relief claim be made, it must also result in a reduction in the Income Tax liability or order to generate exemption from CGT. So unless he thinks he can overturn the decision of the Upper Tribunal, he will have to work on the basis that he needs to create an actual Income Tax liability and claim EIS relief against it to qualify for CGT exemption.

The meaning of "an amount of EIS relief is attributable to the shares", which is a pre-requisite for getting the CGT exemption (TCGA92 S150(2)) is defined in Section 289 ICTA88:

(1) References in this Chapter, in relation to any individual, to the relief attributable to any shares … shall be read, subject to the provisions of this Chapter providing for the reduction or withdrawal of relief, as references to any reduction made in the individual’s liability to income tax which is attributed to those shares … in accordance with this section.”

That wording makes it very clear that if there is no reduction in the liability to income tax, there has been no "relief attributable to the shares". It therefore follows that the CGT exemption fails. However, one of the points discussed in the appeal was whether the definition in S289 ICTA88 also applied to the use of the same phrase within TCGA92, since it starts out by saying "References in this Chapter ..." and TCGA92 is a completely different piece of legislation.

The Upper Tribunal confirmed in several places in their ruling that there needs to be a reduction in Income Tax. For example (underlinings added by me):

28. We consider that the meaning of “attributable” is made clear by section 150A(11) TCGA and section 289B ICTA. Section 150A(11) provides that section 289B (among other sections) applies for the purposes of determining whether EIS relief is attributable to any shares, and if so the amount of relief so attributable. Section 289B(1) provides that “relief attributable to any shares” must be read as a reference to “any reduction made in the individual’s liability to income tax which is attributed to those shares,”. That interpretative provision therefore applies directly to section 150A(1) and (2). Those words are clear and show that “an amount of relief is attributable” in those subsections must be interpreted as referring to a reduction in liability to income tax. 

30. Given that the subject matter of both subsections is the CGT exemption, we consider that they should be interpreted, if possible, to be consistent. In our view, the use of terms in section 150A(3) such as “an individual’s liability to income tax has been reduced” and “the amount of the reduction” supports the interpretation of “an amount of relief is attributable” in section 150A(2) as relief “has been attributed and the individual’s income tax liability reduced as a result”. 

31. In conclusion, it seems to us that the language of section 150A(2) is clear and “an amount of relief is attributable” means that, at the time that the CGT exemption is claimed, a claim for EIS income tax relief must have been made and given effect. We consider that, in the absence of a claim for EIS income tax relief which reduced the individual’s income tax, the individual has no right to the CGT exemption on any subsequent disposal of the shares. 

68. ... Not just a claim but actual relief against income tax is required in order to benefit from CGT exemption. In order to achieve that, Mr Ames would have had to waive in whole or in part his personal allowance. ...

Aceace

Many thanks again @bowlhead99 and @spider42.

In light of the above I'll adjust my strategy for the tax year ending April 2020. I haven't done a tax return for that year yet, so will send a paper one in with a letter to state that I want to claim EIS relief but not my Personal Allowance, as suggested. This will be a bit of a test case to see how it goes. I'll have to get a move on as I think the deadline for doing so is the end of this month. 

Hopefully, I can use my SIPP to generate the necessary tax liability for the 2020/21 tax year, but if not I'll have the tested personal allowance rejection technique to fall back on (there's a small chance that my  interest income will be lower than I've estimated this year, so may still have to rely on the PA rejection, hence my desire to test that I've done it correctly for last year).

A new question that springs to mind: I have multiple EIS investments for each of these tax years. Do I need to be careful to somehow prioritise claiming EIS income tax relief on the ones I think are most likely to generate the highest gains?
Or, would they all automatically qualify for CGT exemption if any one does?

My apologies if this is already covered above. I will read through more carefully when I get some substantial free time (I'm being pressed to "stop mucking about on the net, as there are things more important than money" right now  )
Thanks again. 

spider42

That's a very good question, and definitely not covered already (or in the Ames case). My opinion is that you would qualify for CGT exemption on all of the investments.

My first thought was that it is is possible to make partial EIS claims, i.e. claim for investments in some companies but not others, or to only claim for part of the shares in any company. But I fear this may result in not getting full CGT exemption, since I think the restriction in S150A(3) TCGA1992 may then come into play. It could be argued that the reason the the relief obtained (A) was less than the full relief at 30% (B) wasn't solely because the tax liability was insufficient to obtain full relief, but would also partly be caused by the taxpayer deliberately not claiming relief on all of the qualifying shares.

However, I'm not 100% sure how this provision would be interpreted. If you've only claimed partial relief, but still managed to eliminate the original Income Tax liability in full, then arguably the reason A is less than B is still solely because you didn't have a big enough tax liability in the first place. Even if you had claimed EIS relief on every share, rather than only some of the shares, then this wouldn't change the value of A, which can't exceed the original tax liability. Anyway, that is a bit of a side issue, just mentioned it for completeness!

I think it is safer to make a full Income Tax relief claim for all of your EIS investments. Section 201 Income Tax Act 2007 covers multiple investments.

201Attribution of EIS relief to shares

(1) References in this Part, in relation to any individual, to the EIS relief attributable to any shares or issue of shares are to be read as references to any reduction made in the individual's liability to income tax that is attributed to those shares or that issue in accordance with this section.

This is subject to the provisions of Chapters 6 and 7 providing for the withdrawal or reduction of EIS relief.

(2) If an individual's liability to income tax is reduced in any tax year, then—

(a) if the reduction is obtained because of one issue of shares, the amount of the reduction is attributed to that issue, and

(b) if the reduction is obtained because of two or more issues of shares, the amount of the reduction—

   (i) is apportioned between those issues in the same proportions as the amounts claimed by the individual in respect of each issue, and

   (ii) is attributed to those issues accordingly.

(3) If under this section an amount of any reduction of income tax is attributed to an issue of shares (“the original issue”) to an individual, a proportionate part of that amount is attributed to each share in respect of which the claim was made.

So S201(2)(b) is saying that with multiple investments, the Income Tax reduction received is apportioned between the share issues on a pro-rata basis. Therefore, provided you have received at least some Income Tax reduction, that reduction is spread over all your different EIS share issues. S201(3) then goes further and says that if a reduction is attributed to a share issue, it is attributed to each share in that issue for which a claim was made.

So you claim EIS Income Tax relief for every share. A proportion of the Income Tax reduction is then attributed to each and every share. The sole reason why you didn't get full relief is because you didn't have sufficient tax liability, so S150A(3) doesn't come into play. A small amount of the tax reduction has therefore been attributed to all of your shares. And the shares having been attributed to an amount of EIS relief is the key condition for the CGT exemption in Section 150(2). So all the shares should qualify for CGT relief, provided of course that you and the company continue to comply with all of the other requirements.