A friend has an idea for a small business startup and wants you to help fund it. You’re interested, but is it more tax efficient to do it through your company or use your own cash?
What is tax efficiency?
Putting money into a new company is nearly always risky, but doing it tax efficiently can mean that at least you’ll get something out of the deal if things go wrong. The trouble is, you need to decide what form your investment will take from the start, but because of the way the rules work this might not turn out to be the most tax efficient. Therefore, before you commit you should weigh up the pros and cons of each method.
Personal investment - shares
If you use your own money to buy shares in the new company, the main pros and cons are:
Pros: you might be liable to capital gains tax if you make a gain when you sell the shares. If the company fails and you lose money, you can usually claim a tax deduction for the loss against your other income or capital gains. The company can pay you dividends, which is usually the most tax efficient type of income.
Cons: dividends can only be paid to you where the company makes profits. If the company doesn’t make money you won’t receive any income. Even where the business can pay dividends it can’t claim a tax deduction for them.
Personal investment - loan
You could just lend the money to the company, in which case the plus and minus points are:
Pros: you can charge interest on a loan, meaning you receive income regardless of whether the company is making a profit. Interest is taxable at the highest rate you pay, up to 45%. But if the total interest you receive from all sources is no more than £1,000 (if you’re a basic rate taxpayer) or £500 (if you pay tax at the higher rate - but not the additional rate) it’s chargeable at 0%. The new company can claim a tax deduction for the interest it pays you.
Cons: if the company fails, the loss you make can be set against your capital gains only, not your income. If you don’t have any capital gains, you’ll never get a tax deduction for the loss.
Company investment - shares
If you use your company’s cash to buy shares in the new company, the two main pros are:
- if dividends are paid they are tax exempt for the receiving company
- if your company owns 10% or more of the shares in the new company, any gain it makes when it sells the shares is also tax exempt.
Company investment - loan
Alternatively, where your business lends money to the new company, the main advantages are:
- if the new company fails, the loss your company makes can be deducted from its trading profits chargeable to corporation tax (CT), i.e. unlike a personal loan it doesn’t have to make capital gains to get relief for the loss
- it can charge interest on a loan and only pay tax at CT rates, currently just 19%.
Investing via your company gives more advantages than doing so personally. But you must still choose between buying shares or making a loan to the new company.
Tip: You can get the best of both worlds by initially investing in the form of a loan from your company, but with an option to convert this to shares within, say, five years. That way you’ll get tax advantages while the new company is in the risky early years and others when the company is established.
Happy tax saving!