What happens when investors lose capital?
Loss relief can reduce the impact of losses made on individual companies.
What is loss relief?
EIS investments are shares in small, early-stage companies that aim for high growth. Which means these shares have a higher risk of losing value compared to other investments.
If the value of EIS shares drop to zero, or if the shares are sold for less than the original amount invested, there’s loss relief available. This allows an investor to offset a loss made on an EIS company against either their capital gains tax bill or income tax bill, depending on which better suits their needs.
Remember: an investor can still lose money overall, even if they claim loss relief. While loss relief can reduce the impact of the loss, it won’t eliminate the loss entirely.
How much loss relief can investors claim?
To qualify for loss relief, the value of an investment when it’s sold has to have fallen below what’s called the effective cost (the amount invested minus whatever was claimed in income tax relief).
The available loss relief is equal to the sale proceeds received minus the effective cost. For example, if someone invested £100,000 into EIS shares and claimed upfront income tax relief of £30,000, the effective cost of that investment would be £70,000.
If the company fell to zero value, the available loss relief is £70,000.
Claiming loss relief against income tax
An EIS investor can offset a loss against their income tax bill for the current or previous tax year. The loss is deducted from the investor’s income before income tax is calculated. The value of this relief is worked out by multiplying the value of their effective loss and their marginal rate of income tax.
Claiming loss relief against capital gains tax
It might be more suitable for an investor to offset their loss against their capital gains tax bill for the current tax year. The loss is deducted from the investor’s capital gains before capital gains tax is calculated.
If the loss is bigger than the capital gains for the current year, any excess is carried forward to future tax years and set against the first available gain.
Investors can work out the value of this relief by multiplying the value of their effective loss by their marginal capital gains tax rate.
Calculating the effective loss and loss relief
The example below shows how loss relief is calculated for an EIS-qualifying company where an investment falls to zero.
Companies that become valueless
If shares in an EIS-qualifying company fall in value to zero, investors may have the option of making a negligible value claim. They can do this by informing HMRC that the shares are worth nothing, or next to nothing, even if they haven’t been sold.
The negligible value claim will treat the shares as being sold, sometimes called a “deemed disposal.” This makes it possible to claim loss relief.
If shares are sold in the future, the proceeds will be subject to capital gains tax. If the negligible value claim is made against income in the previous tax year, the shares need to have been of negligible value at that time.
How does loss relief work with a portfolio of EIS companies?
An EIS fund manager will often construct a portfolio of EIS-qualifying companies. However, for loss relief purposes each company is considered a distinct investment.
This means that if any of the individual holdings within the portfolio are sold at a loss, investors can claim loss relief – even if the overall portfolio performance is positive.