Light Relief? – Losses On Private Company Investments

Ken Moody takes us through the ‘ins’ and ‘outs’ of losses on investments in private companies 

Investments in private companies almost inevitably carry a degree of risk. The tax legislation recognises this by providing relief against income tax for losses on shares in private companies, and also for capital loss relief on losses on loans to traders generally – not just to companies. However, HM Revenue & Customs (HMRC) is likely to challenge claims for relief which do not meet the requirements of the legislation in full, and so care is needed. 

Income tax loss relief for investments in shares in unquoted trading companies is provided by the tax legislation (ITA 2007, s 131) (‘Share loss relief’). Relief is available, broadly, where the company meets the enterprise investment scheme (EIS) ‘qualifying trading company’ requirements. The detailed EIS requirements are beyond the scope of this article, but it is not necessary that the company should have applied for EIS status or that the shares should qualify for EIS income tax relief. For example, EIS income tax relief is not available for holdings of more than 30% of the equity of the company (although CGT deferral relief under TCGA 1992, Sch 5B may be available). 

Relief is also available for non-EIS investments, but the company must still be a qualifying trading company (as defined), and certain trades are excluded. These are listed in the legislation (at ITA 2007, s 192), and include financial or property based trades such as: banking, insurance etc; property development; farming; forestry; accountancy/legal services; hotels and nursing homes. The relief is extended to shares in the holding company of a trading group. The investee company must not be under the control of another company, and there is a limit on the gross assets of the company/group of, broadly, £7 million. 

For EIS purposes, shares must be subscribed for in cash whereas if the shares are not EIS shares, for share loss relief the requirement is for the shares to be subscribed for ‘in consideration of money or money’s worth’. In principle, subscription could be by capitalisation of a loan – but there may be a sting in the tail (see ‘Practical Tip’ below).

In order to claim share loss relief, it is first necessary for a capital gains tax (CGT) disposal to occur.  There is a CGT disposal when an asset is lost, destroyed, extinguished etc, or when an asset becomes of negligible value (TCGA 1992, s 24). In the case of the latter, however, a claim must be made and the asset is treated as disposed of at the date of the claim. If the asset had become of negligible value by a date in either of the two preceding tax years, the claim may specify that the disposal should be regarded as having taken place on the earlier date. 

 

 

It was decided in the case Marks v McNally ( [2004] SSCD 503 (Sp C 428)) that there has to be a disposal or deemed disposal for a claim for share loss relief to be made, and so if shares are considered to be worthless a negligible value claim is a pre-requisite. However, when a company is struck off the shares cease to exist, which would itself be a disposal and at that point a negligible value claim becomes otiose. 

In Bert’s case, if the company had been struck off on 31 December 2013, he cannot now make a negligible value claim, and the ‘year of loss’ for the purposes of s 131 is 2013/14.

Claims for share loss relief

A claim for share loss relief must be made by the first anniversary of the self-assessment filing date for the year of loss. In the above example, the year of loss is 2012/13 and a s 131 claim must therefore be made by 31 January 2015. Share loss relief, however, operates in a similar way to relief for trading losses, and so relief may be claimed against income of the year of loss, the preceding year or both years. 

The facility to effectively backdate the disposal date under the negligible value claim combined with the ability to claim relief under s 131 for the year of loss and/or the preceding year gives rise to some planning opportunities to optimise relief. 

Relief for loans to traders

Under the CGT legislation (in TCGA 1992, s253), relief is available for losses on loans to traders generally, but is perhaps most likely to apply to loans by individuals to companies. The relief also extends to losses on guarantees given over loans to traders which are called in by the lender.

The money lent must be used for the purposes of a trade carried on by a borrower who is UK resident. The relief may be claimed when a loan has ‘become irrecoverable’. HMRC argue that for a loan to have ‘become’ irrecoverable, it must have been recoverable to begin with. If the trader is in financial difficulty when the loan was made, it could be argued that the loan did not become irrecoverable, because it was irrecoverable already. 

As regards what is meant by ‘irrecoverable’, HMRC generally do not accept that a loan has become irrecoverable while the borrower is still trading, since there would still be some possibility of recovery. In the writer’s opinion, this sets the bar unreasonably high, because while the debt may still exist on paper there may be no realistic possibility of recovery. And in any case, where relief is claimed under s 253 and any part of the loan is subsequently recovered, the amount recovered is treated as a gain arising on receipt.

Obviously, if the debt had to be completely irrecoverable (as in legally extinguished) for relief to be claimed, there would be no need for such provision. Moreover, if HMRC would not accept that a loan has become irrecoverable while the trade continues, in that case the additional funds injected to keep the business afloat cannot be deemed irrecoverable either. Suffice it to say that some of HMRC’s guidance on the interpretation s 253 remains untested by the Courts. Fortunately, in practice the issues will usually be clear-cut. 

Claims for ‘loans to trader’ relief 

As with a negligible value claim, a claim under s 253 may specify a time in the preceding two tax years when the loan is considered to have become irrecoverable, which would be useful if substantial gains had been realised in either year. However, a capital loss will usually be of less use than an income loss, as it can only be offset against gains for the year in which a s 253 claim is made (unless the debt was bad in either of the preceding two years), or carried forward against future gains.

There is no time limit per se for a claim under s 253 for a loss on a loan to a trader, as the loss arises on claim, but a claim for a loss on a guarantee payment must be made within 5 years of 31 January following the tax year in which the payment was made. 

Practical Tip :

The relative attraction of s 131 over s 253 may tempt the lender to try to take advantage of share loss relief by capitalising the debt (a similar idea worked in the case Fletcher v HMRC ([2008] SpC 711), but the circumstances were unusual). This may, however, turn out to be a ‘double whammy’ because where shares are acquired by capitalisation of debt, TCGA 1992 s 251(3) deems the shares to have been acquired at market value, which may be considerably less than the face value of the debt. Therefore not only might the anticipated s 131 relief evaporate, but also by capitalising the debt there is then no possibility of a claim for a capital loss under s 253.