EIS deferral of residential property gains

The issue

The enterprise investment scheme (EIS) offers tax breaks for investors who invest in small, new trading businesses. Among these tax breaks is a capital gains tax deferral relief which means that gains that would otherwise be taxable can be deferred to the extent that an EIS investment is made. For example if £1,000 of EIS investment is made then £1,000 of gain could be deferred until the EIS shares are disposed of. Unlike EIS income tax relief there is no minimum period that EIS shares need to be held to benefit from EIS deferral.

Although capital gains tax rates went down to 10% (lower rates) and 20% (higher rates) from 6 April 2016, rates for residential properties remained at 18% (lower rates) and 28% (higher rates). The legislation however seems to suggest that a residential property gain can effectively be taxed at the new lower rates if it is deferred through the subscription of EIS shares. This is because the legislation simply brings deferred gains back into charge on disposal of the EIS shares as a deemed gain without directing that it should be treated as a residential property gain.

 

Example

John who is a higher rate taxpayer disposes of his residential rental property for £2M in 2016/2017 realising a gain of £500,000. Ignoring the annual exemption (which he has used elsewhere) his tax at 28% would be £140,000. However he invests £500,000 in an EIS company which he later sells for £500,000. The deferred gain would be taxed at 20% (or £100,000), thus saving £40,000.

 

Words of caution

Clearly there is a lot of risk attached to EIS investment and so it would be unwise to invest in EIS shares to chase an 8% tax saving on a gain, but rather this should be seen as an added bonus. Furthermore, although technically it seems that an EIS investment could be made and shortly after exited in order to secure the saving, there is a requirement that EIS shares must not form part of a tax avoidance scheme. Whether HMRC view this saving as offensive or not remains to be seen. The contrary view is that this is just another tax incentive of EIS!

 

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