What is Investors' Relief and how does it work?

Investing in unlisted trading companies always carries inherent risk – but it also offers the potential for substantial returns.

Plus, it’s a great way to support growing British businesses. That’s why the government introduced Investors' Relief (IR) back in 2016 to reward investors with tax breaks.

While IR doesn’t absorb quite as much limelight as the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), it’s a powerful tool for reducing Capital Gains Tax (CGT) when you invest in unlisted trading companies.

Let's explore how IR works, what it applies to, and who can benefit from it – including recent changes to the scheme as per the 2024 Autumn budget. 

How it works

IR reduces the rate of Capital Gains Tax (CGT) you pay when selling qualifying shares.

While related schemes like EIS and SEIS share the goal of encouraging business growth by attracting investors, they focus on early-stage companies. IR instead broadens horizons to established unlisted trading businesses.

Here are the basic mechanics:

• When you sell or 'dispose of' shares that have increased in value, you typically pay CGT on the gain – the difference between what you paid for the shares and what you sold them for.
• Following the 2024 Autumn Budget, standard CGT rates on shares are 18% for basic rate taxpayers and 24% for higher rate taxpayers. IR reduces this rate significantly for qualifying investments.
• Instead of paying up to 24% CGT ordinarily, with IR, you’ll currently pay 10% CGT until April 5, 2025. After that, the CGT rate under IR will increase, although it will remain much lower than the standard rate. More on this shortly. 

Qualifying for IR

To qualify for IR, your shares and relationship with the company need to meet specific HMRC conditions.

The rules ensure that IR’s tax benefits apply to genuine investments in trading companies – exactly what the relief was designed to support.

Key eligibility requirements include:

• Newly issued shares: Shares must be newly issued ordinary shares, subscribed for in cash, rather than purchased from another shareholder.
• Holding period: Shares must be held for at least three years before being sold.
• Employment restrictions: You can’t be an employee or a paid director of the company, although unpaid directors may qualify.
• Trading status: The company must be a trading company or the holding company of a trading group.
• Commercial purpose: Shares must be issued for legitimate commercial reasons, not for tax avoidance. This is important, as HMRC evaluates whether the shares are issued for commercial purposes on a case-by-case basis. They may assess the company's intentions, the nature of the trade, and how the investment is being used.
• Arm’s-length transactions: Shares must be subscribed for and issued at arm's length – meaning the buyer and seller must act independently, without either party having special influence over the other.
• Restrictions on receiving value: Neither you nor anyone connected to you can receive value from the company during the period from one year before the shares are issued until three years after the issue.

The 'external investor' aspect is critical to IR’s purpose and how it works. Remember, IR is designed to encourage fresh investment into trading companies from investors who are not involved in the company.

Unlike Business Asset Disposal Relief (BADR), there's no minimum shareholding requirement, which requires at least a 5% stake.

The two reliefs share a key feature – both offer reduced CGT on qualifying gains – but BADR is designed for those actively involved in running businesses, while IR caters to external investors.

So, IR is particularly valuable for investors looking to build an investment portfolio without involvement. It's worth noting that while IR reduces your tax liability on successful investments, it's not truly a hedge against investment risk. 

The three-year holding period means you need to be prepared for a longer-term commitment. And as with any investment in unlisted companies, there's always the risk that the company might not succeed.

Remember also – the tax relief only applies to gains. If the shares lose value, you'll still face potential losses.

How much tax relief does Investors' Relief provide?

IR, like BADR and several other forms of tax relief, was in the crosshairs of the 2024 Autumn Budget.

The big change is slashing the lifetime limit – from £10 million to £1 million for qualifying disposals made after October 30, 2024. This aligns IR with BADR’s lifetime allowance, which was reduced to £1 million back in 2020.

The IR tax rate structure is changing in stages. For qualifying disposals, you'll pay:

• 10% CGT until April 5, 2025
• 14% CGT from April 6, 2025 to April 5, 2026
• 18% CGT from April 6, 2026

So, let's say you invested £500,000 in a qualifying trading company in 2021 and plan to sell your shares for £1.5 million. Your gain would be £1 million. The tax you'd pay depends on when you sell:

• Before April 6, 2025: £100,000 (10% rate)
• Between April 6, 2025 and April 5, 2026: £140,000 (14% rate)
• From April 6, 2026: £180,000 (18% rate)

Now let’s compare this against standard CGT rates, which, following the Autumn Budget, are:

• 18% for basic rate taxpayers (on gains from October 30, 2024)
• 24% for higher rate taxpayers (on gains from October 30, 2024)

As we can see, IR still offers valuable tax savings even with the new rates. Take a £1 million gain – under normal CGT rules, a higher rate taxpayer would pay £240,000 in tax.

With IR, they could pay as little as £100,000 (at the 10% rate), £140,000 (at 14%), or £180,000 (at 18%), depending on when they sell.

One more important thing: The new £1 million limit takes into account any IR you've already claimed. So if you've previously claimed IR on £500,000 of gains, you've only got £500,000 left of your lifetime allowance. 

Want to lock in a lower CGT rate? Watch out!

The government knows that investors might try to lock in lower tax rates through clever timing of sale contracts, so anti-forestalling legislation applies to IR, the same as it does BADR.

Let's say you're planning to sell your shares in May 2025, but you want to get the 10% tax rate that applies before April 2025. You might think about signing a sale contract now but completing the sale later.

Anti-forestalling rules are designed to invalidate this tactic – your tax rate will be based on when you actually complete the sale, not when you sign the contract.

IR and BADR: Which relief suits your investment style?

Following the Autumn Budget 2024, IR and BADR now look more similar than ever.

To recap, BADR, previously known as Entrepreneurs' Relief, is designed to incentivise entrepreneurship by reducing CGT on the sale of qualifying business assets. 

Its purpose is to support individuals who have built and invested in businesses, allowing them to retain more of the value they have created when selling their assets or exiting their ventures. Learn more about it here.

Both IR and BADR offer the same tax rates (10% until April 2025, then 14%, then 18% from April 2026), and both have a £1 million lifetime limit. But that's pretty much where the similarities end.

The key difference is in how you engage with the company. BADR is designed for those actively involved in running a business – you need to be an officer or employee and hold at least 5% of the shares.

On the other hand, IR is designed specifically for hands-off investors who aren't actively involved in the business’s operations. To qualify, you can’t be an employee or a paid director of the company.

With that said, it’s sometimes possible to benefit from both reliefs. For instance, if you’re an unpaid non-executive director holding qualifying shares that meet the conditions for both schemes.

IR, EIS & SEIS: Understanding compatible tax relief options

IR, EIS, and SEIS all aim to encourage investment in businesses, but they do so in very different ways.

With SEIS, you receive upfront income tax relief of 50% when you invest, plus a CGT exemption when you sell the shares after three years. SEIS also offers reinvestment relief, allowing you to defer CGT from other gains when you reinvest in SEIS companies.

SEIS is strictly for very early-stage companies, typically raising their first £250,000 of investment. EIS, by contrast, is designed for more advanced companies, offering 30% income tax relief on investments and similar CGT benefits to SEIS.

IR/EIS/SEIS can complement each other. You might use SEIS for riskier early-stage investments where the higher tax reliefs help offset the greater risk, EIS for companies with some proven traction but still growing, and IR for more established trading companies.

The key is understanding how each relief aligns with your investment strategy, risk appetite, and long-term financial goals. 

As ever when it comes to tax, seek professional advice. 

Managing investments through Vestd

Vestd is synced with Companies House, so all your shareholding information stays accurate and up-to-date, plus, our platform helps you:

• Manage your entire investment portfolio in one place
• View accurate digital cap tables of every company you invest in
• Set up and manage Special Purpose Vehicles (SPVs)
• Store all relevant documentation securely

So, when it comes time to make your IR claim, you'll have everything you need in one place, ready to go.

Curious to learn more about how Vestd can help you manage your investments? Book a free, no-obligation chat with our team.

Information correct at the time of publishing. Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'