When taxpayers scurry to meet the annual filing deadline of October 31 and scour for ways to reduce their tax bill, their interest is often piqued by newspaper ads from companies offering tax relief of up to 40pc in exchange for investment.
Indeed, the Employment Investment Incentive Scheme (EIIS) has been a crucial source of funding for micro businesses and small and medium-sized enterprises since the Government introduced it in 2011 to replace the Business Expansion Scheme (BES) and encourage the public to invest in corporate trades during the recession.
But the EII scheme is not without its detractors. Because companies generally have to be less than seven years old to qualify for the EII, they are – by nature – young businesses. If the company you invest in fails, your investment can disappear.
“It needs to be invested as an at-risk investment, according to the legislation, and historically that gave the investment type a bad name,” says Monica Walsh, the principal and founder of SYS Tax, which has a strategic partnership with financial services firm SYS Group, an official fundraising partner for the EIIS Innovation Fund offered by Quintas Wealth Management.
However, EII investing can work in certain circumstances and the market is increasingly offering new ways of mitigating the risks involved in buying shares in young, unquoted businesses.
“Lots of these companies come good and lots have gone off the rails,” Walsh says. “I’ve had people come in a panic looking to mitigate their tax liability with the tax break [offered by the EII scheme], but I would never advise clients on decisions made in haste. You need to mitigate the risk by getting under the bonnet of individual companies and doing due diligence, which a lot of individuals cannot do on their own.”
The following are factors to consider when weighing up EII investing:
How the tax incentive works
Under that scheme, you can get tax breaks of up to 40pc of the amount you invest, if certain conditions are met. You have to be earning more than €40,000 a year to qualify for investing in an EII scheme as you must be paying the higher 40pc rate of income tax and have sufficient taxable income to avail of the tax relief. The minimum investment is €250 but some companies opt for a higher threshold for EIIS investors, often from €5,000 to €10,000. If you invest €10,000 in a scheme, you would reduce your income tax liability by €4,000, though you cannot claim relief against PRSI or USC.
If you have a larger lump sum to invest, you can put in as much as €250,000 into a qualifying company and still claim the 40pc relief if you hold the shares for four years. If you invest €500,000, you must hold the shares for seven years.
To claim the relief, you have to get a Statement of Qualification from the company you’ve invested in. If you’re self-employed, you can make the claim through your annual Form 11 income tax return, while PAYE workers can claim the relief by submitting a Form 12 via the MyAccount portal on the Revenue website.
Tax relief on rental income
In addition to the potential for a return on your investment, the EII scheme is one of Ireland’s few remaining sources of total income tax relief. Most people are aware of the generous tax relief that comes with pension contributions, but that relief only applies to tax on earned income. You can use the EII to get tax relief on everything from rental income to dividends to employee share options you’ve exercised. The incentive also appeals to high-earning taxpayers who have fully maxed out the relief offered by pension contributions.
“You have PAYE workers who work in tech and pharma companies who might get a bonus or go to sell share options and want a home for the money and the 40pc tax relief,” says Nick Charalambous, who, as managing director of Cork-based Alpha Wealth, chooses EII companies for clients to invest in.
Walsh says landlords also avail of the scheme.
“As a single person, if you have €20,000 rental income a year in addition to your salary of, let’s say €50,000, your €20,000 of rental income will all be subject to the higher 40pc income tax rate,” she says. “If you paid €20,000 into an EIIS, you could fully shelter that rental income from income tax.
“However, there’s no point in getting tax relief if you don’t get money back from the scheme. People put money in pensions and then don’t look at them again. We should be looking at how our investments are doing on an annual basis, including our EIIS.”
Investing in EII funds
Investing a lump sum directly in a fledgling company through the EII scheme in a private placement just to benefit from tax relief is a risky move because you could lose your entire investment.
To reduce the risk, you could invest through a designated investment fund that’s been approved by Revenue or through a qualifying investment fund.
More funds are gradually coming on the market that – in exchange for a fee of about 3pc – choose which companies to invest in and help diversify the risk. These funds typically invest in between three to eight companies a year for their portfolios. One of the recent tweaks to the complex rules around EII were tweaked to allow venture capital funding to enter the market, paving the way for venture capital firm Elkstone to set up its EIIS early-stage venture fund.
BES Management DAC, a joint venture company between BDO and Davy Stockbrokers, manages the Davy EIIS Funds, and is the country’s longest-running EIIS fund manager. It has raised and invested more than €215m in BES and EIIS funding over the past 25 years, investing in more than 150 companies, including The Happy Pear and Gym+Coffee.
“We are part of the rising tide of funds out there,” says Sinéad Heaney, a partner at BDO Dublin and the director of BES Management. “When you are an individual investing in shares in private companies and there isn’t an open market for those shares, that’s what puts them into the high-risk category. Because of that, it makes sense to deal with a professional fund manager and it does de-risk it somewhat.”
BES Management raised €10m in funds in December and is currently carrying out due diligence on companies seeking EII funding. The minimum you can put into the fund is €5,000, though the average investment level is €40,000 to €50,000, Heaney says.
“A lot of the investment above €50,000 would come from Davy private clients who have a high net worth and are spreading risk throughout their portfolios,” she says. “But there are a number of PAYE people who get in at the €5,000 level because they want the tax break.”
While BES Management doesn’t publicly reveal the performance of its funds, Heaney says “70pc of our investors are repeat investors every year”.
Goodbody EIIS Funds have invested in Powerscourt Distillery.
Monitoring investee companies
Investing in a managed fund enables you to benefit from the expertise of investment professionals that can choose the investee companies by sifting the wheat from the chaff.
Mark Richardson, a partner at Azets Ireland (formerly Baker Tilly) who is investment director for the Goodbody EIIS Funds, which have raised €77m and invested in companies such as the Powerscourt Distillery, says: “We have assets team who spend 100pc of their time on investing and managing the funds.
“We ask for quarterly management accounts from companies, we would take a right to a board seat (though not necessarily exercise that right), and we attend management and board meetings of companies. When we get management accounts, we look to meet with CEO or the CFO to see how things are going.”
Tweaking the scheme
The EII, which allows companies to raise as much as €5m over 12 months and €15m under a lifetime limit, has been tweaked in recent years to reduce the complexity of the scheme and revive its use.
In the past, there are well-known cases of delays in investors receiving their tax certificates and delays in schemes getting approval through Revenue, prompting some SMEs to abandon plans to raise finance this way altogether.
Budget 2022 extended the scheme for a further three years and relaxed the rules on when the relief should be paid back in the event of an investor redeeming their shares. In the Finance Act 2019, a new self-certification-based system to replace the existing Revenue approval system allowed investors and investee companies to take responsibility for fulfilling the scheme's conditions. This meant that once an investment takes place, a company can issue a Statement of Qualification to investors so they can claim their tax relief. Investors no longer have to wait until companies have spent 30pc of their investment to avail of the tax relief, which has reduced the time investors have to wait for their tax certificate to claim the tax break.
Heaney of BES says: “We had awful delays before because it could take months to get the tax sorted out through Revenue. Now, once the money is invested in a company, [an investor] can get the tax break almost straight away.”
