Is investing in share capital rather than a loan to the directors’ current account more tax efficient?
Since 2008, investing money in the form of shares rather than loaning money to the company means that if the company folds you will have a tax advantage and will be able to set the loss against your income tax bill.
Deciding between shares or a loan when starting a new company or putting more cash into an existing one like everything presents pros and cons, but the savvy business investor should prepare for the best outcome even in the worst circumstances, ask how can I hold on to more of my capital should the company fail? In my view, this is in the form of shares.
Before 2008, shares offered tax advantages but inflexibility was its main drawback since, once invested in shares, the money was tied or the investor faced the long journey through the courts to get it back. Since 2008, however, in order to repay share capital, companies need only pass a special resolution and send this to Companies House along with a solvency statement signed by all the directors. The process is fast and costs nothing.
What are the tax advantages or disadvantages of shares versus loans?
If you lend money to your company and it folds, you can claim a tax loss but only to reduce a Capital Gains Tax bill for the year you lose your money or a later one.
The financial advantage for directors in choosing shares rather than loans is that if you put your money into the company in the form of shares and the company folds, this loss can be used either against a CGT bill or to reduce your income tax liability for the year of the loss or the previous one.
Morvan and Stuart start a company, MS Ltd, with £80,000. They hold minimal share capital of £100 and the remainder is given over to MS as a loan. Each of them receives an annual salary of £35,000 on which they pay tax of around £5,500. When MS folds after a year, after paying off their creditors, there is no money left for Morvan and Stuart so they claim a tax loss on the £79,999 loan, but as there is no capital gain so this loss cannot be set off. This loss has to be carried forward and can be set off only against future capital gains. What a waste of opportunity to claim losses? They can claim the £100 loss of their share capital against the income tax paid on their salary, which as basic rate taxpayers, nets them a collective £20 refund from HMRC.
Directors’ share capital
Morvan and Stuart start a company, MS Ltd, and receive shares for their £80,000 investment. When the company folds, the loss is set against income tax paid on their salaries of £35,000 each. Adding the tax loss to their basic tax-free allowances means that they each receive a refund of £5,500. A total refund of £11,000 compared to £20 received with a loan.
Shares are the way to go to hold on to more of your investment. If your company currently owes you money, consider exchanging this for more shares, by converting the loan to share capital. That way, if the company fails and you lose some or all of your investment, at least you will be able to set the resulting loss against either income tax or CGT.