Financing companies and tax relief

Your company or perhaps a company of a relative requires additional finance to expand. You have the funds to help. What is the best way to provide the funds to the company?

The natural inclination is to make a loan to the company rather than an issue of shares by the company. Loans have the advantage of simplicity in the initial lending to the company and the repayment or partial repayment of the loan when the funds are no longer required by the company. For the issue of shares, the formalities of the issue and repayment of share capital have to be considered.

The optimist, ie the person who thinks the monies will soon be repaid, will prefer the simplicity of a loan arrangement. However, one should always guard against the possibility that the finance will not be repaid because the company may get into such financial difficulties that it is forced to be wound up. A loss will have been made by the provider of the finance but can that blow be softened by any tax relief? Here’s where the shareholder wins out over the loan provider.

How much relief is available?

A loss made on a loan made to a trading company potentially qualifies as a capital loss and thus is available to relieve against capital gains in the year in which the loss relief is claimed or in a future year. The maximum tax relief therefore is 28%, for example if the gain was on the disposal of certain residential properties but other gains may well be taxed at lower rates than this.

A loss made on shares is also a capital loss but there is a potential claim that can be made to offset the gain against income in the year of the loss and/or the previous year. So a higher rate taxpayer could get 40% tax relief.

So why not make a loan and then convert into shares if problems are anticipated?

We could then have the best of both worlds? The short answer is no. There can be significant problems with such an approach. HMRC may look into the claim to use the loss against income to see if the company was in financial difficulty at the time the shares were issued in exchange for the loan. They may consider various statutory provisions in the tax legislation so as to restrict the acquisition cost of the shares to a lower figure than the amount of the loan given up for the shares.

Alternatively, HMRC may question the loss claim if it is made as a ‘negligible value’ claim ie there is no actual disposal of the shares but a deemed disposal. One of the seemingly innocuous provisions of such a claim is that the shares, at the time of the claim, have become irrecoverable. This may mean that HMRC can argue that no relief is available if the business was in such difficulties at the time the shares were issued that the shares should be regarded as irrecoverable from the outset.

One further tip – if you are considering that the finance should be in the form of shares which are envisaged as being repayable to you in due course, it is often sensible that these shares are of a separate class to the other share capital of the company. This will allow the repayment to be made to you easier (and not create tax issues).

Please do talk to us if you are considering additional finance for your company or any other company. It is better to weigh up the advantages and disadvantages of the different methods at an early stage.