EIS Compliance Guidance
Introduced by the UK government in 1994, the Enterprise Investment Scheme was created in order to assist small UK companies raise capital from private investment. In return for providing enterprise capital to small unlisted businesses (there are size and industry restrictions on the businesses that are eligible), who might otherwise struggle to attract funding, EIS investors are rewarded with generous tax incentives.
Since its introduction, the EIS market has grown significantly, and EIS shares have been issued across a range of industries. Whilst investing in EIS is not without risks, the incentives for investors looking at tax planning opportunities are considerable, with subsequent government legislation expanding the potential tax reliefs even further.
Historically, these products were often termed UCIS (unregulated collective investment schemes), although this has not always been technically correct. UCIS products now fall under the new non-mainstream pooled investments (NMPI) regulations. However, most EIS and SEIS products are excluded from the NMPI marketing restrictions and may be considered and promoted (subject to general suitability requirements) to all retail clients by adviser firms.
To provide advisers with the information required to appropriately recommend EIS products, Deepbridge has compiled the below compliance suggestions. These notes should be taken as generic guidance only and we recommend deferring to your compliance support provider for full guidance.
The FCA and Financial Ombudsman Service consider EIS and SEIS products to be amongst the very highest risk of all retail investment products as they involve investing in small companies. Companies which attract EIS status are, by their nature, small and it is widely accepted that small companies tend to have a higher failure rate than larger companies. This risk is increased when the companies involved are newly formed, such as SEIS eligible businesses.
Deepbridge’s experienced and skilful business builders adopt a hands-on and engaged approach with all underlying investee companies in order to ensure that risk is mitigated as much as possible. Whilst this approach ensures that Deepbridge investments are as risk mitigated as possible, the very nature of this type of investment product means that the regulator will always deem the level of risk to be high. Where appropriate, Deepbridge will utilise asset backed investments or businesses which attract Government guarantees to further reduce the capital risk.
The higher risk associated with these products is why generous tax incentives are offered.
Under HMRC rules, EIS and SEIS investments must be held for a specified term of 3 years in order to qualify for the maximum tax relief and after that time may still be considered illiquid, depending on the exit strategy. Therefore EIS are generally only suitable for clients who will not need access to their invested capital during this period.
In a majority of cases, the regulator would only deem investment products of this nature suitable for clients with a high attitude to risk and high capacity for loss. However, it is accepted that there may be occasions when clients with lower attitudes to risk could still be advised to invest in these products; as long as the need for tax mitigation and planning was clearly made. For clients with an attitude to risk at the lowest end of the spectrum it is unlikely there will be many scenarios where a recommendation to invest in a product which buys single company shares for small start-up businesses could be deemed suitable.
Advisers should also take into account the amount of available capital being invested into EIS products, due to their perceived high risk. There are no set constraints determining the percentage of a client’s assets which are suitable for investment into these products; however it is suggested that firms make an assessment based on the level of risk presented against the client’s capacity for loss for the capital in question. Deepbridge’s investment funds are made up of a number of investee companies in order to spread the risk; however advisers may wish to consider distributing investments across Deepbridge offerings in order to spread the risk.
All Deepbridge companies have received advance assurance from the HMRC before investment.
KNOW YOUR CUSTOMER
Most compliance support providers provide clear guidance regarding what advisers need to document as part of their KYC obligations, when recommending EIS products. All compliance guidance states that KYC information on file, including factfind information, should contain full details as to why the client wishes to invest in these products and full details of the client’s tax position if there is a need to mitigate income or capital gains tax. If the client wishes to mitigate potential inheritance tax then a full assessment of the client’s IHT position should also be held on file. The tax calculations retained on file should clearly show ‘before and after’.
It is also important for the file to record full details of the client’s existing assets to show what capital is available and what the client’s portfolio looks like prior to the recommendation – advisers should also utilise this information when establishing the client’s knowledge and experience. Specialist tax planning investment products are sophisticated products and they will not be suitable for all clients, even those with a high attitude to risk.
It is generally advisable that advisers record soft facts and discussion notes to record that the risks of this type of product has been discussed and understood. If products have reduced or limited FSCS protection it is also recommended that KYC documentation confirms that this has been explained to the client.
In general, for Suitability Reports, it is important advisers highlight the risk of the product being recommended. As EIS products are considered to be high risk retail investment products it is recommended that the Suitability Report describes these products as high risk; although it is prudent to highlight how Deepbridge products are lower risk than other comparable products within this broader high risk bracket. Deepbridge can help provide research and due diligence for advisers to retain on file as evidence as to why the product has been recommended as the most suitable for the client.
If you require any assistance when recommending an EIS offering, please contact the Deepbridge Technical Team.
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