UK Tax Planning

How to finance a new Limited Company

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When a company is first established it will likely require the transfer of cash in order to make initial purchases of stock, property, and material, in addition to covering basic running costs.

There are two main ways to finance a new company: equity injection (typically meaning the purchase of share capital), or debt.

Many companies use a combination of these two methods, but in this chapter, we explore the main advantages and disadvantages of each so that you can determine the best financing options for your company.

The advantages of debt

Many company owners choose to initially finance their businesses by investing personal money in the form of a loan. This is known as an Entrepreneurs transfer, and it is reflected on the books as an outstanding balance, owed by the company to the owner. This type of funding provides many advantages, both personally and to the business.

Because the funds are categorised as a loan, the shareholder can extract from the company without incurring income tax or national insurance. This is because extractions up to the initial funding amount can be classified as loan repayments and therefore are not taxed.

In addition, as the lender, you can establish whatever interest rate you desire to be paid by the company. In this case, the company would be able to deduct the interest rate amount from taxes, but you would be liable for the interest payment on your personal taxes (though you would not be liable for national insurance).

For UK residents, there are very few restrictions on how much debt your company can start off with. If you are a non-UK resident, however, there are additional provisions that you need to look into when determining the debt amount for your company.

One disadvantage of starting your company in debt, however, is that if your business is operating at a loss then you could potentially lose your initial investment.

There can be complex tax implications of financing your company via debt. Most debts are considered simple debts, meaning that there is no gain for the disposal of the loan or loss if the loan becomes irrevocable. With these simple debts, there is no tax relief for the loss of loan funding.

However, different rules may apply when the loan is made to a trader, supplying special relief for losses. In order to qualify for this relief, the loan must fit the following conditions:

  • The loan was for cash
  • It was made out to a UK resident
  • It was exclusively for the purposes of the borrower’s trade or for setting up the trade. If the borrower never commences in trade the loan does not qualify.
  • The loan was not carried out between spouses or related companies
  • The loan must not be assigned

In addition, investment companies (such as property investment companies) do not qualify for tax relief.

If these conditions are met, the loss of the loan can be treated as a capital loss.

As long as you follow loan regulations and meet the conditions listed above, you can finance your business with a starter loan and secure yourself some relief from losses in the event of irrevocable debt, by claiming it as a capital loss. Capital losses can only be offset by capital gains, not income, meaning that you can counterbalance a loss by selling some company assets.

What is the position with equity injection/share capital financing?

The other way to finance your company is by investing cash through share capital. This investment value then becomes the base price of the shares for tax purposes. Under this financing method, if the company is wound up, it could crystallise a capital loss equal to the initial cost (assuming no proceeds).

If the shares were unquoted, however, and if they are subscribed for directly from the business, you could classify the loss as an income loss. This is a significant advantage for many companies because income losses can be offset against other incomes—such as employment income or dividend income.

On the other hand, if the initial financing was a loan account, the best you could obtain is a capital loss.

The main disadvantage of acquiring share capital is that you cannot extract cash tax-free from the company. In order to extract cash, you would be liable for a 25% tax for higher rate taxpayers (basic rate taxpayers would not suffer any additional income tax).