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Tax breaks encourage private company investment

Birmingham Post Private Equity Supplement - November 2011

Earlier this year, the tax incentives to invest in smaller businesses were given a boost, making the Enterprise Investment Scheme (EIS) a tax concession of real value.

EIS provides individuals with tax relief of 30 per cent of the cost of their investment in equity shares of many kinds of privately owned businesses. The relief means that taxpayers can immediately reduce their income tax bills by 30 per cent of the cash injection.

For the tax relief rules to apply, investments can be made in qualifying businesses with fewer than 250 employees as long as gross assets are no more than £15m before the additional investment.

To have the benefit of income tax relief, investors, who must not be employees, must not control the company or own more than 30 per cent of the shares (including shares held by close family and associates). The maximum investment level for an individual is to be doubled to £1m by April next year.

Income tax relief is not the only tax benefit. Increases in the value of shares are exempt from capital gains tax if the shares are held for three years or more.

All this is of no benefit if the investee company does not survive and ultimately trade profitability and private company investments can be risky.

However, despite this, investment in private equity can pay off. Figures from the British Venture Capital Association (BVCA) suggest that private equity provided returns of 16.3 per cent in the five years to 2012, compared with just 5.1 per cent growth in the FT All Share Index.

Even allowing for the risks of investing in unlisted companies, the EIS and other tax savings can make investing in private firms a particularly good opportunity, assuming that the right investment opportunities can be found and checked out.

This is where the main challenge lies but investors can reduce the risks involved by looking closely at the business before investment or asking their accountants or other advisors to do so.

Alternatively, it may be possible to reduce the risk by investigating alongside fund managers with experience of due diligence enquiries and the monitoring of private company investments.

A number of fund managers offer this kind of opportunity and professional advice is needed.

If the investee company does fail in the event, always possible for an early stage innovative business, despite the caution of the investor, the EIS rules provide for some relief against income tax or capital gains tax for losses caused to the investor by the demise of the business.

There is another potentially valuable tax break for EIS-based investments - the shares taken, if held for more than two years, will often be eligible for business property relief, making them effectively exempt from inheritance tax in many cases.

This exemption goes much further than private companies. Businesses with this exemption currently include public companies quoted on the Alternative Investment Market (AIM).

There are real opportunities to get alongside exciting young businesses that will boost the regional and national economy. The tax breaks make the investment especially interesting.

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