In the past, we posted a number of blogs on the subject of EIS and inheritance tax considerations, such as Why SEIS/EIS Inheritance Tax Relief Should Matter To You Now, Pensions & EIS, revisited, and How To Identify Pension & Investment Scams. So now, I write this article to refresh our consideration of this important topic in light of the current macroeconomic environment and because...it impacts everyone.

Inheritance Tax (IHT) is colloquially known as the "voluntary tax," yet statistics from HMRC challenge this notion. As of June 2023, IHT receipts reached a record monthly high of £795 million, with a grim projection to rise to £7.2 billion for the 2023/24 tax year and up to £8.4 billion by 2027/28. Given soaring inflation and property values, more families are worrying about exceeding the set tax-free allowance thresholds. 

The basics 

Understanding the fundamentals of IHT is crucial. The tax generally applies at a rate of 40% on assets passed on to beneficiaries over a certain threshold. For single homeowners leaving assets to direct descendants, the tax-free threshold currently stands at up to £500,000 (£1 million for married couples or civil partnerships). While there are exemptions and reliefs, the intricate web of regulations demands prudent strategic planning to optimise estate value.

The figures

According to recent studies by The Telegraph, business owners face the disquieting prospect of up to 72% of their assets ending up paid to HMRC under current rules. Even those earning £60,000 a year face an effective tax rate of 56%! Given these startling figures, it is important that we all consider this matter and take action by finding out what methods are available to mitigate this impact.

EIS as an effective tool for inheritance tax relief

Business Property Relief (BPR) offers substantial benefits when it comes to reducing Inheritance Tax (IHT) liabilities. BPR provides 100% relief on qualifying assets such as unquoted or some AIM companies, if held for a period of at least two years. Investors can put unlimited amounts into BPR-qualifying companies, even hold these investments in an ISA for tax-free growth and income, all while retaining full control and ownership of their assets. The current tax regime allows for full IHT relief after just two years, which is considerably faster than most other IHT mitigation strategies like gifts and trusts, which typically require a seven-year holding period.

EIS offers this advantage, in essence providing 100% relief from IHT on qualifying investments held for at least two years. Under current rules, if shares qualify for EIS relief, they effectively qualify for BPR, which makes EIS a two-pronged approach for tax planning. The primary benefit is that EIS investments are IHT-exempt after only two years, thus falling under BPR rules. Investors can contribute up to £1 million annually into EIS and even extend this limit to £2 million if investing in knowledge-intensive companies.

The combination of BPR and EIS can act as a robust financial planning tool to substantially reduce, if not entirely wipe out, an estate’s IHT liability within a relatively short period. 

The EIS competitive advantage

EIS stands out as an attractive IHT planning tool for several compelling reasons. Firstly, the scheme allows for significantly higher annual investment limits—up to £1 million, or £2 million if invested in knowledge-intensive companies. This higher ceiling permits rapid IHT planning in contrast to the slower pace of most other IHT-mitigation methods. Secondly, EIS investments achieve IHT-exempt status in just two years, unlike the seven years commonly required for trusts and gifts. This speed is particularly valuable for those seeking to quickly secure their financial legacies. 

Moreover, EIS investments offer more than just IHT relief; they come with additional tax incentives such as income tax and capital gains tax relief. EIS shares that qualify for relief also usually meet BPR conditions, which adds an extra layer of IHT mitigation. Furthermore, investors maintain complete control over their assets during their lifetime—a privilege not often available with other strategies such as certain types of trusts. While EIS investments are not without risk, given that they're generally in early-stage companies, the risk-reward ratio is often considered favourable, particularly when backed by substantial tax incentives. Therefore, with proper consultation from financial advisors, EIS provides an effective and multi-faceted tool for experienced investors looking to mitigate their IHT liabilities while also enjoying other tax benefits.

Amid rising IHT receipts and shifting policies, proactive estate planning has never been more important. While IHT ultimately provides the capital required to maintain the country’s infrastructure, adeptly navigating its complexities enables you to pass on more of your hard-earned wealth to your children.  Given the financial stakes involved and the evolving nature of tax law, diligent planning and professional advice are indispensable. With strategic choices in investment portfolios like BPR, EIS, and SEIS, you can meaningfully mitigate your IHT liability and preserve your estate's value for future generations.  Unless, that is, you prefer to contribute more to the public purse - the choice is yours.

Sapphire Capital Partners LLP is authorised and regulated by the Financial Conduct Authority (FRN: 565716). This article is a financial promotion and is intended for UK investors only. The content is for information purposes only and does not constitute investment advice or a recommendation to invest. SEIS and EIS tax reliefs depend on individual circumstances and may change. The value of investments may go down as well as up, and investors may not get back the full amount invested. Past performance is not a reliable indicator of future performance.  Investment outcomes can differ substantially, potentially resulting in the loss of all your capital invested. Shares in early-stage companies are illiquid: you may be unable to sell your holding for several years, if at all. Investors should not rely on this article as a basis for investment decisions and must consider the illiquid and high-risk nature of early-stage investing. No warranty as to future outcome is implied nor should one be inferred. Tax treatment depends on individual circumstances and may be subject to change. Investments of this type are generally not covered by the Financial Services Compensation Scheme or the Financial Ombudsman Service if the underlying companies fail.