Tax Reliefs for Impact Investing in the United Kingdom: What You Should Know
The United Kingdom, like other markets, has seen rapid growth in the popularity of “impact investing,” where the investor’s intention is to create a social or environmental benefit as well as a financial return. The size of the global impact investment market was estimated in 2019 at $502 billion, and the UK Government recently backed the launch of the Impact Investing Institute to encourage further growth of the sector in the United Kingdom. The expansion of impact investing in the United Kingdom may be facilitated by the use of long-standing reliefs for investment in small unquoted companies to make the investments in a tax-efficient manner.
These reliefs are generous. The enterprise investment scheme (EIS), which applies to companies with gross assets of up to £15 million, grants individuals income tax relief at a 30% rate on equity investments in qualifying companies of up to £1 million a year, as well as an exemption from capital gains tax on disposal of the investment and a rollover of prior capital gains until that disposal. The seed enterprise investment scheme (SEIS), which is targeted at start-ups with assets of £200,000 or less, grants income tax relief at a 50% rate (which currently exceeds the top income tax rate of 45%). The social investment tax relief works in a similar way to the EIS, but extends relief to debt investments in charities and other similar social enterprises, and can be claimed by certain types of businesses that are not eligible for EIS or SEIS status (such as those providing legal and accountancy services).
The reliefs also permit the establishment of fund structures to enable individuals to diversify their EIS portfolio. Whilst generally described as “funds”, these are structured in a different manner to traditional private equity funds. The EIS legislation requires individuals to own shares beneficially in the underlying investee company. Accordingly, an EIS fund is generally structured as a nominee company which holds legal title to the shares in the investee companies on behalf of the investors.
In order for investors to obtain one of the reliefs, the investee company must obtain approval of its EIS status from HM Revenue & Customs (HMRC). The legislation also provides a mechanism for EIS funds (but not SEIS funds) to obtain HMRC approval. EIS funds are not obliged to seek approval, but approval enables investors to claim relief in the tax year in which the fund closes, rather than when it makes the investment in the underlying companies.
As investors are now able to carry back EIS relief to the preceding year, approved status offers minimal advantages in practice, and relatively few funds have sought it in recent years given the additional compliance obligations it involves. From April 2020, the approved funds regime will only apply to funds investing predominantly in companies engaged in knowledge-intensive businesses, but will allow investors to carry back their relief to the tax year before the one in which the fund closes.
Whilst these changes to the approved funds regime are unlikely to increase its appeal to the social investment sector, unapproved funds can still be attractive vehicles for social investment. Investors and promoters should also be aware that social investment tax relief is subject to a sunset clause, which will result in its disappearance in April 2021, unless it is renewed. To that end, the Government has recently been consulting on the future of the relief, and an announcement is expected in the near future. If this relief does disappear, it will remove the ability for charities (which do not issue equity capital) to raise money on the basis of these reliefs, and preclude other entities from raising debt capital in this manner.
Given the Government’s desire to encourage this sector, it would feel somewhat perverse if the principal tax relief targeted at it were withdrawn—together with EIS and SEIS relief (which will remain), there is the potential for it to serve as a catalyst for more social impact finance transactions to be brought to market.