Guidance
Notes > Tax Relief for Losses or Investments
These
guidance notes are provided as a general summary of the
current legislation on tax reliefs for losses on investments
in unquoted trading companies. These notes are not
a substitute for appropriate professional advice in respect
of the specific circumstances of any particular situation
and anyone relying on these notes without taking professional
advice before acting does so at their own risk. No
liability or responsibility is accepted for any loss occasioned
by any person acting, or refraining from acting, as a result
of reading these notes.
Introduction
These
notes help to explain the tax reliefs available for losses
incurred by investors in unquoted trading companies and
businesses, describe the practical steps which must be taken
to secure those reliefs. The notes only apply to
individual investors and hence, do not cover the reliefs
available for corporate venturing, i.e. to investors who
are companies.
Whether
or not relief is due depends upon certain conditions being
fulfilled. In attempting to summarise the rules in
a straightforward way, there are likely to be situations
which the notes do not cover and where professional advice
will be necessary.
An
investor in a company tends to be thought of as a person
holding shares in a company. However, a person can
also invest in a company by lending money to it.
Reliefs are available for shareholders and loan creditors.
Further, losses on shares in unquoted trading companies
may be offset against either current or future capital gains
or by way of deduction from the shareholder's taxable income.
Relief for losses on loans to traders does not apply
solely to loans to companies but to loans to traders in
general e.g. a sole trader or a partnership.
The
relief also extends to losses on guarantees given for third
party loans to traders although such relief is available
for capital gains tax purposes only.
Whilst
it may appear more desirable to invest in an unquoted trading
company by buying shares, the downside is that share capital
tends not to be repaid other than in special circumstances,
whereas a loan can be. On the other hand, if the
company succeeds, an investment in shares will enable the
investor to participate in the prosperity of the company
in the form of dividends and/or capital growth, whilst a
loan will attract interest but no capital growth.
Where
the shareholders are also the directors and involved in
running the company, it may well be the case that the share
capital of the company is nominal e.g. £100, and that
any finance provided by them will be in the form of directors'
loans. Indeed, when incorporating a business carried
on by a sole trader or partnership, one tax-planning objectives
is to create credit balances on directors' loan accounts,
consisting of the proceeds of sale of the business to the
company. To the extent that these proceeds represent
profits on chargeable assets, they will generally be liable
to capital gains tax but with the reliefs currently available
for business assets, the tax liability may be less than
10% of any capital gain realised on the assets sold.
In
practice, all combinations of equity and loan finance are
found and whatever the reasons for the original structure
adopted, it is an unfortunate but realistic aspect of corporate
life that investee entities fail from time to time.
At that point, the issue of whether any tax reliefs are
available will require to be considered.
Guarantee
Payments
Capital
gains tax relief is available in respect of guarantee payments
made to third parties in connection with monies lent to
UK traders.
Loans
to Traders
Capital
gains tax relief is available in respect of losses on loans
to UK traders which become irrecoverable.
Share
Losses
Capital
gains tax relief is available in respect of losses incurred
on share investments. As an alternative, income tax
relief may be obtained in respect of losses incurred on
share investments of unquoted shares, excluding fixed rate
dividend preference shares, in a trading company and subject
to certain conditions.
Relief
for losses on shares in unquoted trading companies
- Introduction
- Income tax relief
- Eligible shares
- Subscription for shares
- Unquoted companies
- Required period of trading
- Trading requirements
- Excluded companies
- Eligible companies
- Qualifying trades
- Qualifying disposals
- Mixed holdings
- Negligible value
- Time limits
- Application and use of loss
- Restriction of loss relief due to EIS relief
Introduction
If
a loss arises on either the actual or deemed disposal of
shares in an unquoted company, capital gains tax relief
is available. Such loss relief can be offset against
gains realised in the same tax year or to the extent not
so utilised, may be carried forward and offset against capital
gains in future years.
In
certain circumstances, income tax relief may also be available
which tends to be more attractive than capital gains tax
relief because the effective rate of relief for income tax,
often 40%, is greater than for capital gains tax, where
it is rare to pay 40% due to indexation, taper relief and
the annual exemption. Further income tax relief tends
to be obtained in the year of the loss whereas capital gains
tax relief is dependent upon a capital gain being realised
against which the loss can be set.
The
key conditions for receiving income tax relief are that
the shares on which the loss arises must not be, or have
been, quoted on a recognised stock exchange, the company
must be a UK trading company involved in a qualifying trade,
the shares must have been acquired by subscription and they
must not be fixed-rate preference in nature. Further
guidance can be found in H M Revenue & Customs help
sheet IR286.
Income
tax relief
Income
tax relief for losses incurred on shares in eligible unquoted
trading companies is given by virtue of section 574 of the
Income and Corporation Taxes Act 1988m “section 574” and
operates in a similar way to the relief for business losses
of a sole-trader or partnership. It can be given
either for the tax year in which the loss arose or for the
previous year. Professional assistance is encouraged
in terms of calculating and claiming the relief.
The
availability of income tax loss relief recognises the degree
of risk inherent in investing by subscription for shares
in unquoted companies which perhaps explains why investment
tax relief up to 40% is available for the loss in the case
of a higher rate taxpayer.
The
rules for shares issued before 6 April 1998 are slightly
different than for shares issued after that date but in
most instances the changes will not be relevant.
For shares issued on or after 6 April 1998 a company is
an eligible company if its activities are such that it would
be a qualifying company for the purposes of the Enterprise
Investment Scheme “EIS”. The relief under section
574 interacts with the EIS provisions to some extent and
again, professional advice is strongly recommended in order
to ensure that the most advantageous claim is submitted.
The tax reliefs under EIS are only available if both
the individual and the company meet various conditions.
Section 574 relief refers mainly to a company's activities
and shares which qualify for relief under section 574 will
not necessarily have qualified for EIS relief.
Eligible
Shares
Any
shares acquired by subscription in an eligible unquoted
company will qualify, except fixed-rate dividend preference
shares. There is no minimum period of ownership required
to secure relief under section 574 although H M Revenue
& Customs may deny relief if the investment was made
after it was deemed that the company/business was not a
going concern and could not avoid financial failure.
Subscription
for shares
Relief
under section 574 is only available for shares which have
been acquired by subscription or by way of a lifetime transfer
from a spouse who themselves acquired the shares by way
of subscription. Shares are subscribed for if issued
in consideration for money or money's worth and thus, shares
issued in consideration for the transfer of an asset to
the company would qualify. Shares could also be subscribed
for by capitalising a credit balance on a loan account.
Again, care is required because the acquisition cost
of the shares for capital gains tax purposes is their market
value on issue and if the company was in financial difficulty
at that time the value of any share issued could be less
than the face value of any loan account balance subsequently
created.
As
noted above, if the company can reasonably have been expected
to fail at the time of investment, a claim for relief under
section 574 is unlikely to be successful. The shares
issued as a result of such investment may be deemed to be
worthless at the time of issue which will restrict relief
to the value of the shares rather than the face value of
the loan balance converted.
Unquoted
companies
To
qualify for relief the company must not be, or have been,
quoted on a recognised stock exchange at the time of the
relevant share subscription (or for subscriptions before
6 April 1998 been quoted within the previous twelve months
prior to the share subscription date). For this purpose
the Unlisted Securities Market “USM” or the Alternative
Investment Market “AIM” are not recognised stock exchanges
and it will only be companies listed on the main Stock Exchange
which are excluded. The companies to which relief
applies therefore will generally be private trading companies
and USM/AIM entities. There must be no arrangements
in place at the time of issue of the shares whereby the
company may cease to be unquoted but otherwise, the company
may still qualify if it subsequently ceases to be an unquoted
company on or after 7 March 2001 .
Required
period of trading
If
the company was a trading company when the shares are disposed
of, it must have either traded throughout the six year period
ending with the date of disposal, or throughout its active
existence if less than six years.
If
the company had ceased to trade at the date of disposal
it must not have ceased trading more than three years earlier
and must have traded for the period mentioned in the preceding
paragraph. Also it must not have commenced any non-qualifying
business since ceasing to trade such as property investment.
Trading
requirements
If
the shares were issued before 6 April 1998 the company must
always have been resident in the UK and its business consist
wholly or mainly of the carrying on of a trade. For
shares issued on or after 6 April 1998 the company must
have traded wholly or mainly in the UK throughout the relevant
period which is the period ending on the date of disposal
and commencing on the date of incorporation or, if later,
one year before the date that the shares were issued.
For shares issued before 6 April 1988 , the location of
the company's trade is not relevant and the company's business
can include non-trade activities provided such activities
do not amount to more than 50% of the total. For
shares issued on or after 6 April 1998 , more than one half
of the company's trade must be carried on in the UK.
Also
any non-trade activities must be minimal and any non-qualifying
trade activities should not amount to more than 20% of the
total.
Excluded
companies
Certain
companies are specifically excluded from relief under section
574. An excluded company means one which:
(a) Has a trade
which consists wholly or mainly of dealing in land, commodities,
futures, shares, securities or other financial instruments,
or is not operated, on a commercial basis such that profits
may reasonably be expected. Thus, ‘hobby' activities
are excluded.
(b) Is the holding
company of a non-trading group.
(c) Is a building
society, a registered industrial or a provident society.
Eligible
companies
For
shares issued after 6 April 1998 the company must also be
an eligible company, i.e. one which would qualify as such
under the EIS rules. For this purpose, the company
must exist wholly for the purpose of carrying on one or
more qualifying trades as noted below. If the company
carried on any other activities these must be capable of
having no significant effect on the extent of the company's
activities.
Thus,
non-trading activities must be trivial or incidental e.g.
retaining short term surplus funds on deposit would not
normally disqualify the company. Relief also extends
to the parent company of a trading group but the question
of non-trading activities having a significant effect will
apply to the group as a whole. In addition, as for
shares issued before 6 April 1998 the company must not be
an excluded company.
Qualifying
trades
A
qualifying trade is one which does not consist to any substantial
extent of any of the following:
(a)
Dealing in land, commodities, futures, shares, securities
or other financial instruments.
(b)
Dealing in goods otherwise than in the course of an ordinary
trade of either wholesale or retail distribution.
(c)
Banking, insurance, money-lending, debt-factoring, hire-purchase
financing or other financial activities.
(d)
Leasing
(e)
Providing legal or accountancy services.
(f)
Property development.
(g)
Farming or market gardening.
(h)
Holding, managing or occupying woodlands or any other
forestry or timber production.
(i)
Operating or managing hotels or similar establishments,
or managing property used as such.
(j)
Operating or managing nursing homes or residential care
homes, or managing property used as such.
(k)
Providing services for any of the above where the services
are under the common control of the person providing the
non qualifying services.
There
are certain exceptions to the above rules and again, professional
advice should be sought but, as a general rule, H M Revenue
& Customs tend to regard ‘substantial' as meaning 20%
or more.
Qualifying
disposals
To
qualify for relief the disposal of the shares must be:
(a)
For full consideration in a bargain made at arm's length
i.e. not between persons who are connected with each other,
such as certain relatives, or
(b)
By way of a distribution in the course of winding up the
company. A distribution made to shareholders by
the liquidator of a company is treated as a disposal or
part-disposal of their shares, or
(c)
Where no distribution is received but the shares cease
to exist on the company being either liquidated or struck
off by the registrar of companies, or
(d)
Where the shares are deemed to be disposed of as a result
of a claim that the shares are of negligible value.
Relief
is available if the shares are not the original shares issued
but were issued in exchange for the original shares under
a company reconstruction, provided that relief would have
been available in respect of the original shares.
This may occur where, for example, one company has taken
over another by way of a share exchange.
Mixed
holdings
Special
rules apply where the shares disposed of are part of a holding,
some of which were acquired by subscription and some by
other means e.g. transfer by way of gift or acquisition
of existing shares by way of purchase from another shareholder.
If there is any question over which shares are qualifying
shares, the disposal is deemed to be of the shares acquired
later rather than earlier. If the qualifying shares
are part of a holding, a claim under section 574 cannot
be for more than if the shares were not part of a holding,
i.e. more than they cost. This restriction relates
to shares acquired before 6
April
1998 where the capital gains tax regulations require that
the costs are pooled, so that the proportionate cost calculated
on disposal of part of the pool may be greater than the
actual cost of that ‘parcel' of shares. Disposals
out of mixed holdings including shares acquired under the
former Business Expansion Scheme or Reinvestment Relief
rules are subject to further special rules and professional
advice is recommended.
Negligible
value
If
the company becomes insolvent and ceases to trade it may
be that there will be no funds available for shareholders,
and if the company became dormant thereafter, there is no
event which would trigger a disposal for capital gains tax
purposes. A distribution made by the liquidator of
a company is treated as a disposal, or part disposal, of
the shares, which is the same treatment as a distribution
where the company is to be dissolved by being struck-off
under the procedure provided for by section 652A of the
Companies Act 1985. This allows the registrar of
companies to strike-off the company on an application by
its directors, provided certain conditions are fulfilled,
and saves the expense of formal liquidation proceedings.
In those circumstances, by extra statutory concession,
on application to the company's Inspector of Taxes, distributions
to shareholders may be treated as though they had been made
during liquidation, and are thus capital distributions rather
than income distributions.
Loss
relief may also be claimed in respect of the destruction
or extinguishment of an asset, however if the company is
not dissolved but remains dormant the shares will still
exist even though they are worthless. The
capital gains legislation provides that where an asset,
i.e. shares in this case, has become of negligible value,
relief for the capital loss may be claimed. H M Revenue
& Customs regards negligible value as meaning ‘worth
next to nothing'. If accepted by the local Inspector,
the claim gives rise to a deemed disposal and thus a capital
loss, which in turn allows a claim to be made under section
574.
Where
a negligible value claim is made, the asset in question
is deemed to have been disposed of at the date of the claim.
However, the facility exists for the claim to be
treated as having been made at an earlier date by specifying
a date during the last two years of assessment before the
year of claim to be the deemed date of disposal, provided
that the asset was already of negligible value by that date.
Time
limits
A
claim for relief under section 574 must be made within 12
months of 31 January next following the year of assessment
in which the loss arose. For example, if the loss
arises in the year to 5 April 2006 ,
31
January next will be 31 January 2007 and 12 months after
that will be 31 January 2008 . The claim is normally
made as part of the tax return submission process.
The
ability to date a negligible value claim up to two years
earlier should always be considered in connection with a
loss relief claim under section 574. Where the company
is placed in liquidation it will usually be evident from
the liquidator's statement of affairs whether there are
funds available for distribution to shareholders.
Thus it will be clear at an early stage of the insolvency
proceedings whether the shares are likely to be subject
to a negligible value claim.
For
example, if a company goes into liquidation in June 2005
and there is no distribution to shareholders, the shares
would be worthless as of June 2005. However, it may
be that the shares had become worthless by say, 31 March
2005 . A loss arising in 2005-2006 by reference to
the date of liquidation may be given either for that year
or for 2004-2005. However a shareholder's income
for those years may have been quite small if he worked for
the company and it had not been doing very well since 2003
due to for example, the loss of a major contract.
As a result earned income for those years may be insufficient
to absorb the loss and also, such shareholder may have only
been liable to tax at the basic rate on the basis of the
salary received. However, if the shareholder's income
from the company in 2003/2004 was substantial and was liable
to higher rate tax, such income might be sufficient to absorb
the loss. It makes tax and cashflow sense to specify
31 March 2005 as the date that the shares were worthless
assuming local Inspector agreement for capital gains tax
purposes, so that 2004-2005 becomes the year of loss.
This in turn enables relief to be claimed either 2004-2005
or the previous year 2003-2004, and thus gain higher tax
rate relief. A claim for the deemed disposal to be
treated as occurring in 2003-2004 must be made with H M
Revenue & Customs by 31 January 2006.
Application
and use of loss
The
loss on disposal, or deemed disposal, of the shares in the
company is a capital loss. Such loss is available
for offset against capital gains arising in the year of
loss, or in subsequent years. Loss relief is given
against earned income and if one's income in the year of
loss and/or the preceding year are not sufficient to fully
absorb the loss, the balance may be offset against capital
gains in the year of loss, or carried forward as a capital
loss without time limit for offset against future capital
gains.
Restriction
of loss relief due to EIS relief
Shares
issued by a company which is a qualifying company for EIS
purposes, may attract income tax relief at 20% of the cost
of the shares. A capital gain arising on disposal
of shares in an EIS company
is
normally exempt, but a loss would be an allowable loss.
This will create the possibility of a capital loss
claim which will be reduced by the income tax relief given.
For example, if £10,000 were subscribed and
income tax relief at 20% obtained i.e. £2,000,
when the company fails and the shares become of negligible
value, the loss is restricted to £8,000.
Relief
for losses on loans to unquoted trading companies and businesses
- Introduction
- The relief
- Timing
- When is a loan recoverable?
- Directors' loan accounts
- Guarantees
- Timing
- Claims
- Recovery of amount(s) claimed
Introduction
As
mentioned above, relief for losses on loans to traders is,
a more general relief and applies to loans to sole traders
and partnerships as well as loans to companies. However,
it is only available for capital gains tax purposes i.e.
no income tax relief is provided, and is claimed in respect
of certain business loans which have become irrecoverable.
Even if relief is restricted to the capital gains
tax regime, it should be claimed because even if it cannot
be offset against capital gains in the short term, it can
be carried forward indefinitely and used in the future.
Similar
relief is available when a person has guaranteed a loan
made to a trader by a third party and has been called upon
by the third party to meet the guarantee on default of the
borrower.
For
these reliefs, the borrower is required to be a UK-resident
trader but there are no restrictions on the trades which
qualify nor, in the case of a company, on the type of company
which qualifies. A simple debt, to which the relief
applies, is a straightforward loan between two parties.
A debt for money raised by larger concerns on the
financial markets is more likely to be tradeable instrument
e.g. loan stock, debentures, bonds etc., rather than a simple
debt and, once again, professional advice is strongly recommended.
Since
most loans to traders by individuals are not debts on securities,
they are exempt from capital gains tax in the normal way
which means that if the debtor does not repay the loan there
is no allowable loss. One cannot circumvent this
by passing the debt to a person connected with you so that
they can claim loss relief because losses on such transactions
are specifically excluded from relief.
The
relief
Relief
for losses on private loans to traders, as opposed to loans
by a bank or other lending institution which are of course
in the business of lending money, was introduced in 1978
and applies where:
(a)
The money lent is used by the borrower wholly for the
purposes of a trade carried on by him, and is not a trade
which consists of, or includes, the lending of money;
(b)
The borrower is resident in the UK ; and
(c)
The debt is not a debt on a security. Special rules apply
to these debts and fall outwith the scope of these notes.
Relief
is only available where:
(a)
The loan is wholly or partially irrecoverable;
(b)
The lender has not assigned his right to recover the irrecoverable
amount e.g. to a debt collector; and
(c)
The lender and the borrower are neither husband and wife
nor members of the same group of companies.
Timing
The
loss arises when one submits a claim to H M Revenue &
Customs that the debt has become irrecoverable either in
whole or in part. As with negligible value claims, the loss
may be deemed to have arisen in either of the two tax years
preceding the year in which the loss arose, provided it
can be shown to have been irrecoverable at that earlier
time. This may be useful, where a substantial capital
gain arose in either of those two years against which the
loss could be offset or alternatively, if a current year
claim might result in some loss of the annual exemption.
When
is a loan irrecoverable?
A
loan does not become irrecoverable simply because it is
not repaid on its due date or, where repayable on demand,
payment is not made when demanded. There must be
no reasonable prospect of recovering the loan, or so much
of it as is the subject of the claim. For example,
if one has lent £10,000 to a company which has gone
into liquidation and the liquidator advises that he expects
a dividend of 20p in the pound to unsecured creditors, the
balance of £8,000 would be deemed to be irrecoverable
at that time.
Directors'
loan accounts
Where
a company owes directors monies and payment cannot be made
i.e. due to liquidation, a claim may be made in the same
way as for other simple debts, provided of course that the
money has been used by the company for the purposes of its
trade and lent to the company when there was a reasonable
commercial prospect of it being repaid.
Guarantees
Loss
relief is also available to a person who has guaranteed
a loan on behalf of a trader who is unable to repay it and
the guarantee is called upon by the lender. The conditions
for relief are similar to the relief for loans to traders
as noted above. In this situation, relief is available
where a guarantor and the borrower are members of a group
of companies i.e. where one group company guarantees a loan
to another group company from a third party such as a bank.
The guarantee must have been given after 11 April
1978 and relief is available for guarantees in respect of
both simple debts and a debt on a security.
Time
A
loss incurred under a guarantee arises for the year of assessment
when payment under the guarantee is made. There is
no opportunity to deem such loss to have arisen in an earlier
period, as is the case with loans.
Claims
Losses
on loans to traders do not have a prescribed time limit
for making a claim because the legislation simply requires
that the loan had become irrecoverable, in whole or in part,
at the time the claim is made. However, the loan
must be still in existence when the claim is made i.e. one
must not have waived or released the loan, or converted
it into shares.
Claims
for losses on guarantees of loans to traders may be made
for capital gains tax purposes up to the fifth anniversary
of 31 January next after the year of assessment in which
the payment under the guarantee was made.
The
allowable loss is the amount payable under the guarantee
but relief is limited if there exists an entitlement to
receive any contribution from co-guarantors up to the extent
that they are able to pay.
Recovery
of amount(s) claimed
If, any amount
is recovered, after relief has been claimed for a loan which
was thought to be irrecoverable or for a payment under a
guarantee, the amount recovered is treated as a chargeable
gain in the year of recovery.
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