SHARE CAPITAL VS DIRECTOR'S LOAN
When you start a Limited Company you have the choice of what to do with your start-up capital. You can either loan it to the Company or issue share capital to the value of the money you're investing. The question I often get asked is - which one is the best option?
It's an interesting question because while one option will give you a potential tax benefit, there are other considerations which might make you think twice.
Example:- Rob sets up a new Company with a main activity of selling colour-changing nail polish. To set the Company up Rob needs to buy stock of £30,000 and pay for social media management and a website up-front of £10,000. Rob will pay for these with his own money. He has the choice of loaning £40,000 to the Company, repayable on demand, or the Company can issue 40,000 £1 Ordinary Shares to Rob in exchange for his money. Which one is preferable?
LOANING THE COMPANY MONEY
There are no tax advantages to loaning the Company the money. But that's not to say it should be ignored. Although there are no tax advantages, there is a cash-flow advantage. By lending the Company money, it can be repaid to you as soon as the Company has generated enough cash from sales to do so. This might be important if you need the £40,000 for other things (i.e. you only intended it as a short-term financing option).
ISSUING SHARE CAPITAL
By issuing share capital you're making a longer-term commitment to the Company. You cannot choose to have your investment repaid to you as soon as the funds become available. You can arrange for the Company to buy your shares back off you, but this option is not straight forward and will probably result in you incurring solicitors fees, which makes this option quite unattractive.
So, are there any circumstances where issuing shares might be preferable? You'll note that in the above example we have only considered what happens if the Company is successful. However, it is a sad fact of life that 50% of all new start-ups fail within the first 4 years.
If, in our example, Rob loans £40,000 to the Company and the business fails before it pays any of that money back, then all he can do with his £40,000 loan is carry it forward as a capital loss. And capital losses can only be offset against capital gains.
However, if instead of a loan Rob had received shares in exchange for his money, he could have made a negligible value claim CG13131. This would allow Rob to set the loss on his shares against ALL his income in the same year the negligible value claim is made. Therefore, if, in the year the negligible value claim is made, Rob had started a job in order to make ends meet, he could set the value of the shares (£40,000) against his earned income and receive a tax refund. Assuming Rob was earning £50,000 this would generate a refund of approximately £9,000.
Tax tip 1:- We do not know the future, therefore cannot determine which option would be more beneficial. Therefore, why not hedge your bets and loan half your capital to the Company and invest the remainder in shares?
Tax tip 2:- If you are likely to make capital gains in the future (i.e. you have a rental property) then a Company loan could be preferable because you will be able set any capital loss on the loan against your future gains on the property.