Small companies are big business in the UK. In 2016 small businesses accounted for 99.3% of all private sector business, making them an intrinsic part of the economy. For investors, investing in small companies makes good business sense.
[When you consider that even the largest of global brands often start out small, seeking investment, it’s worth taking some time to review your investments. After all, Apple didn’t grow from a fully formed tree, but from a seed in Steve Jobs’ garage.]
Finding the seeds and understanding the reasons to invest is one part of the challenge. Another is understanding tax relief and the different schemes available to investors. In this article, Peter Stamps, founder of FD Business outlines your options and opportunities.
Do the risks outweigh the returns in small business investment?
Although small caps are high-risk investments they can deliver good returns. Small stocks in general (based on the Numis Smaller Companies Index) have been regularly outperforming larger counterparts in the FTSE All-Share. The potential benefits of small company investments are numerous, however main highlights are:
- Small companies can have a greater growth potential than larger, more established companies.
- Investors often look to smaller companies for growing dividends.
- Small companies have a higher rate of mergers and acquisitions, which often results in faster realisation of returns.
Investment schemes for small companies
Understanding the tax relief (or lack of) on potential investments can be daunting. While many small caps can be appealing for investors, certain factors can preclude them from potential purchase. For example, some schemes are free from inheritance tax, others aren’t. Some are stamp duty free, or exempt from capital gains tax, or both. There are several schemes and tax relief opportunities available:
Enterprise Investment scheme
Designed to help higher-risk companies attract investment, it offers tax relief on new share purchases. Scheme qualification requirements state:
- must not be listed on any recognised stock exchange when the shares are issued (this excludes AIM and the PLUS Markets, which are not recognised)
- must not be controlled by another company
- must not have gross assets over £15 million
- must have fewer than 250 full-time employees
- is allowed subsidiaries, but they must be qualifying and not be controlled by another company
- must buy full-risk ordinary shares in full (not through any loan)
- must not be connected to the company – by controlling it, or holding more than 30% of the share capital or voting rights (includes partners, employees and directors).
Income tax relief - Relief at 30% of the cost of shares for that investment tax year is available, up to £1,000,000 in investment. Shares must be held for three years.
Capital gains tax exemption - Where share purchase has enabled received income tax relief, no CGT is due when shares are disposed of after three years.
Loss relief - If shares are disposed of at a loss, that loss can be set against income for that year, (instead of gains).
Capital gains tax deferral relief - Available for investors to defer a gain made on any asset into the purchase of EIS shares within a qualifying period, until the date the shares are disposed of. Relief is claimed through self-assessment and is withdrawn if the investor becomes connected or the company no longer qualifies (within three years of purchase).
Seed enterprise investment scheme
Similar to the EIS above, the SEIS is tailored to young, early stage companies, that can struggle to gain investment. To reward investment the tax relief available is higher.
Income tax relief - Relief is 50% of the cost of shares, up to a maximum annual £100,000 investment. Claims can be made up to five years after investment and shares must be held for a minimum of 3 years.
Capital gains tax reinvestment – Assets sold and reinvested (all or in part) in shares that qualify for SEIS are exempt from CGT at the rate of:
– 100% in 2012/13, with an annual investment limit of £100,000. The final claim
date is 31 Jan 2019.
– 50% in 2013/14, with an annual investment limit of £50,000. The final claim date
is 31 January 2020.
Disposal relief – Where share purchase has enabled income tax relief no CGT is due on disposal profits, providing shares are disposed of after three years.
Venture Capital trusts
VCTs offer similar tax relief options to the EIS and SEIS, but they are handled by fund managers. Investors subscribe to the VCT, which then invests in qualifying companies. VCT qualifying companies must be listed on a UK-recognised exchange and have fewer than 250 full-time employees. Tax relief is available to investors:
Income tax - Relief at 30% on a maximum investment of £200,000. Shares must be held for five years.
Dividends – Dividends from VCT investments are exempt from income tax, providing the original investment was not more than £200,000.
Capital Gains Tax – Investments in VCTs are permanently exempt from CGT, with no minimum ownerships period. Losses cannot offset other investment CGT liability.
Sign-up for our newsletter for regular business news direct to your Inbox.