business finance, Business Services, Business Tax, eis, Personal tax, Small Business

Loans vs shares? – Navigate the tax implications of investing in a business

By Simon Paterson

Setting up your own company involves financial investment and many clients ask us whether this is best done by investing in shares in the company, or by making a loan to the company. There are pros and cons to each route; these will also depend on whether it is your own company, or one you are investing in as an outside investor.

This blog explains the pros and cons of each route and the tax implications of investing in a business, summarising what you need to know to make an informed decision.

Tax implications of investing in shares

Pros

This can help to make a company look well capitalised by increasing the share capital – which is potentially significant in the event of future exit planning or attracting additional investors;
If you have borrowed money to purchase shares in a close company (i.e. one which has shareholders of 5 or fewer people or is controlled by its employees) which is a trading company, you can claim tax relief on interest paid on the loan, subject to certain restrictions;
If the company is a qualifying EIS company, subscribing for shares provides an opportunity to claim EIS income tax relief on a maximum investment of £1,000,000 and for a maximum shareholding of 30%; any growth in value of the shares can also be free of capital gains tax;
There is a potential to ‘roll-over’ any other capital gains into EIS qualifying shares;
The shares may give rise to dividend payments.

Cons

Getting your money out again may not be easy and relies on a sale of your shares. The buyer could be the company itself if you eventually wish to leave; it could be other new or existing shareholders; or you may sell your shares as part of a trade sale of the company as a whole;
What if the investment is unsuccessful? If the company is a close trading company you can claim capital loss relief. In certain circumstances, and subject to certain restrictions, it may be possible to offset the loss against other taxable income, which can make it less painful.

Tax implications of making a loan to a company

Pros

This option can be more flexible because the loan can be withdrawn at any time if the company no longer needs it, subject to the agreement of the directors;
There may be the potential to earn interest on a loan depending on the terms of your loan agreement with the company. Any interest received will be subject to a 20% withholding tax and should be declared as part of your total income on your self assessment tax return.

Cons

No tax reliefs can be claimed compared with the potential to claim EIS relief on a share investment. If you have borrowed money to make a loan to a close trading company, tax relief can be claimed on the loan interest paid, subject to certain restrictions;
If the company gets into difficulties you may not be able to recover your loan. If the loan becomes irrecoverable, you can claim capital loss relief if the company is a close trading company. However this loss can only be used to offset against capital gains in the same year or future years;
Making a loan to a company does not provide an opportunity to participate in the growth of the company in the same way that investment in shares does.

In summary, whilst a loan provides more flexibility, share investment can provide more tax saving potential, and opportunity for growth.

If you would like more information about the pros and cons of EIS and attracting additional business investment, please contact Simon Paterson at sp@rjp.co.uk

How to get onboard with RJP

Talk to us

Have an initial discussion with a member of the RJP team to identify ways we can enhance your business's growth with our comprehensive support and strategic advice.

Hassle-free migration

Choose RJP and we'll smoothly manage all transitions, handling paperwork, coordinating with your current accountant, and ensuring no deadlines are missed for a worry-free experience.

A pathway to growth

Finally, we will send you the required documents to sign and return, leaving you to continue leading your business, backed by our abundant, responsive advice and support.

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