Many early-stage startup investors tend to focus on the ROI they’ll get from their investments. But they don’t always consider how much taxes they’ll incur.
If you’re an investor planning to file for an SEIS or EIS tax claim, you’ll be required to submit a Capital Gains Tax (CGT) summary when filing your claim.
This requirement can confuse some investors, especially those investing in EIS or SEIS startups for the first time. That’s because it’s unclear why this information is needed.
This article will explain why investors must submit a CGT summary when filing for SEIS or EIS claims, what’s required, and how to compute for it.
What is Capital Gains Tax?
Capital Gains Tax (CGT) is a tax on the profit made when you sell, give away or dispose an asset that increased in value. The tax is levied on a wide range of assets, including property, investments, businesses and even personal possessions.
While CGT is not an income tax, it can still significantly impact your finances, particularly if you own assets that have substantially increased in value.
For example, if you invest in a startup for £5,000 and sold your equity later for £25,000, your capital gain is £20,000.
Some assets are tax-free; if all your annual gains are below your tax-free allowance, you don’t need to pay any CGT.
If you live in the UK, you’re subject to CGT on sales of assets anywhere in the world, not just those acquired locally.
Are Foreign Investors Required to Pay Capital Gains Tax?
If you’re a non-resident, you must pay CGT to conduct business in the UK. You could also be subject to CGT on selling UK equity shares if you are a non-resident (even during the overseas portion of a split year).
Those who ordinarily dwell in the UK but temporarily reside outside the UK are subject to specific CGT restrictions (broadly, this means non-resident in the UK for less than five years).
When you donate an asset as a gift to someone, you may have to pay CGT. There are unique reliefs for gifts of company assets, and the regulations vary based on whom you donate the gift. CGT may also be applicable if you transfer assets due to a separation, divorce, or dissolution of a civil partnership.
You may occasionally be treated as though you have disposed of an asset.
This may occur, for instance, if a personal item, such as an antique, has been destroyed and you have received a capital sum as compensation—for example, a payout from a startup you invested.
Why You Need to Submit This When Filing for SEIS or EIS Claims
Firstly, it’s worth noting that both SEIS and EIS offer generous tax incentives to investors who invest in eligible startups.
Under the SEIS scheme, investors can receive up to 50% tax relief on investments of up to £100,000 per tax year.
On the other hand EIS scheme, investors can receive up to 30% tax relief on investments of up to £1 million per tax year.
These tax incentives are designed to encourage investment in early-stage startups, and can make it easier for UK startups to raise the capital they need to launch and scale.
However, you must meet specific eligibility criteria to claim tax relief under the SEIS or EIS government schemes.
One of these criteria is that you must not have exceeded their annual CGT allowance in the tax year when you invested.
The annual CGT allowance is the amount of capital gains an investor can make each year before they are required to pay CGT. For the tax year 2021/22, it’s £12,300.
Another reason you need to submit a Capital Gains Tax summary when filing your claim is that when you make an SEIS or EIS investment, you are effectively acquiring shares in a company.
If those shares increase in value, and you decide to sell them later, you’ll be liable to pay CGT on the profit you make.
This is where the CGT summary comes in.
By submitting a summary of your CGT history, you can demonstrate that you have not exceeded their annual CGT allowance, and are therefore eligible for EIS or SEIS tax relief.
How to Compute Your Capital Gains Tax
The amount of CGT payable is calculated by subtracting the asset’s cost from the sale price or market value, and then applying the appropriate tax rate to the resulting profit.
But first, you’ll need to understand that the capital gains tax rate you pay depends on your income tax bracket.
If you are a basic rate taxpayer (earning up to £50,270 in the 2021/22 tax year), you will pay a 10% capital gains tax on gains from the sale of assets, while higher rate taxpayers (earning over £50,270) will pay 20%.
Every individual also has a tax-free allowance for capital gains tax.
In the 2021/22 tax year, this allowance is £12,300. This means you won’t have to pay any capital gains tax if you make a capital gain below this threshold.
If your capital gain exceeds this amount, you’ll only pay capital gains tax on the amount above the threshold.
For example, if you sell a share portfolio for a profit of £20,000, you will only pay capital gains tax on the £7,700 above the threshold. This is calculated by subtracting the tax-free allowance of £12,300 from the total gain of £20,000.
Here’s how to compute your capital gains tax:
Step 1: Work Out Your Taxable Gains
This is the profit you make from selling an asset minus any allowable costs. Example of this are legal fees or surveyor costs.
For example, if you sell shares from an EIS or SEIS-certified startup for £30,000 and you originally bought it for £20,000, your profit would be £10,000.
Step 2: Deduct Allowable Costs from Your Taxable Gain
Examples of this include legal and financial advisor fees.
For instance, if you incurred legal and financial advisor fees totalling £5,000, your taxable gain would be £9,500.
Step 3: Subtract Your Capital Gains Tax Allowance
Once you have calculated your taxable gain, deduct your tax-free allowance of £12,300. If you are a higher-rate taxpayer, multiply the remaining gain by 20%.
For example, if you made a taxable gain of £95,000, your capital gains tax is £16,540.
This is calculated by subtracting the tax-free allowance of £12,300, leaving a taxable gain of £82,700. This amount is multiplied by 20%, resulting in a capital gains tax bill of £16,540.
Tips to Minimise Your Capital Gains Tax
1. Consider Long-Term Investments
You’ll only need to pay capital gains tax if you hold on to your shares for a long time.
This is easier said than done.
For starters, a company’s success can alter over time.
Also, there are various situations where you may decide to sell sooner than you planned.
2. Capitalise Tax-Deferred Retirement Plans
Your money will increase when you invest without being subject to current taxes. You can also buy and sell investments in your retirement account without incurring capital gains tax.
When you take money from a typical retirement plan, your gains will be taxed as regular income. Although you could be in a lower tax band by that point than when you were working.
Investors nearing retirement may want to hold off selling investments outside these accounts until they are no longer employed.
If your retirement income is low enough, it could significantly decrease your capital gains tax bill.
However, if the capital gain is substantial enough, you’ll still have to pay capital gains tax.
3. Offset Your Gains with Losses
If you invest in an early-stage startup, sometimes things don’t work out as you hoped. When that happens, you can offset the losses towards the gains from your other investments.
Naturally, all of your assets would increase. But because losses can occur, this is one method to gain from them.
As an early-stage startup investor filing an EIS or SEIS tax relief claim, you must meet specific eligibility criteria. One of these criteria is that you must not exceed your annual CGT allowance.
Calculating capital gains tax in the UK can seem complex. But by understanding the basic principles, you can work out what you owe.
Remember to consider any allowable costs and tax-free allowances. Use the correct tax rate depending on your income tax bracket.
By submitting your CGT summary, you can demonstrate that you are eligible for tax relief.
More importantly, it’ll increase the chances that your claim will be processed as quickly as possible.