Wednesday 27 February 2019 10:24 am

The EIS has cost the government £3bn in tax relief, so why has it become more generous?

Follow John Glencross
The enterprise investment scheme (EIS) celebrates its silver jubilee this year. Announced by the then chancellor Ken Clarke in the Autumn Budget in 1993, the scheme was launched at the beginning of 1994.

The benefits of the EIS have remained generous – in fact, they’ve become more generous. Until April 2011, the up-front tax relief was 20 per cent. Today it is 30 per cent.

Those aren’t the only benefits: your investments are free of capital gains tax, you get loss relief, and your pot becomes inheritance tax free after two years. By investing via the EIS, you also have the option of deferring capital gains on assets outside of the wrap.

Compare that with what has happened towards pensions in recent years – just a decade ago you could put £255,000 into your pension each year. Now it is £40,000, and only £10,000 for the highest earners.

Since 1994, 27,905 companies have received investment of over £18bn via the EIS. It is estimated that, in the past decade alone, the EIS has cost the Treasury over £3bn in tax relief.

So why does the government continue to offer EIS investors such generous tax breaks?

The reason for this is simple: it benefits the economy by supporting innovation, which in turn increases productivity, creates jobs, and boosts growth. Our research suggests that in the long term it actually makes the Treasury money.

Statistics show that the UK punches above its weight in terms of enterprise creation. According to OECD figures, the UK created more than any other European country in 2015 (the latest available figures).

In 2017, 382,000 businesses were launched in the UK – down marginally from a high of 414,000 in 2016 (perhaps not helped by Brexit uncertainty).

The long-term trend is very positive.

There has been a substantial rise in the number of business launches in Britain over the last decade, and that compares favourably with what is happening in the US, which is often seen as the home of the entrepreneur.

Take the decade to 2016: the number of businesses created in Britain rose by 62 per cent in that time, while the number of new firms in the US actually fell by 22 per cent.

Entrepreneurship requires capital, and I have no doubt that the growing popularity of the EIS and the funding it makes available is a factor in Britain’s entrepreneurial revival.

Many of our European competitors envy us these schemes, because they connect investors looking for a tax-efficient home for their wealth to entrepreneurs with the ideas, talent and drive to make the most of it.

Job creation could result in a profit for the Treasury, which has obvious benefits for the UK economy.

How many jobs need to be created for the Treasury to break even on the tax relief it gives on an EIS investment? According to our research, the answer is nine jobs per £1m of EIS investment.

This assumes jobs are created for three years and have an average remuneration of £35,000.

Here’s how we worked out the numbers: the cost of EIS investment to the Treasury, taking into account the upfront tax relief, is £300,000 on an investment of £1m. If nine jobs were created for three years, with an average remuneration of £35,000 for each job, the Treasury would receive £305,000 in tax over the three years based on 2019/20 rates (each person would pay £11,302.94 in income tax and national insurance).

Since most jobs in EIS-funded companies are held for much longer than three years, it is likely that in the long term the Treasury stands to receive a profit on its outlay. What’s apparent is that the rewards of offering these tax breaks can quickly outpace the costs.

The Treasury does not give money away easily, but these figures show why the EIS offers one of the few generous tax breaks to have survived in the long term.

And by being a legitimate, government-approved way of reducing your tax bill, it is a win-win situation.

Not only can it be self-financing, but many EIS-eligible firms are bringing new innovations to market that have wide-reaching benefits – not just for the economy, but for society.