You’ve been asked to invest in your son’s business or, failing that, stand as a guarantor for a loan. You believe the business will succeed but if it fails does one type of investment have tax advantages over the others?
Are you an angel or just a guarantor?
Various surveys show that the Bank of Mum and Dad is more popular than ever whether it’s for a son or daughter to buy a home or start a business. In the latter situation you could provide the cash by acquiring a share of the business or just lend the money or, if you can’t or are unwilling to do either, you could do the next best thing by standing as a guarantor for a loan. How do the tax consequences for each of these stack up against each other?
Providing the cash
If you have the money and can afford to part with it, at least for a while, to help your child get their business off the ground, there are broadly two ways to go about it. Lend the money or buy a stake in the business. Either way you won’t get any tax relief for the money you commit except in limited circumstances.
Tip. If the business operates through a company, which is a trading company that meets various conditions, it can issue you with shares in exchange for your cash which qualify for enterprise investment scheme (EIS) relief. This provides extra tax advantages such as income tax relief equal to 30% of the amount you pay for the shares and no capital gains tax (CGT) if the shares grow in value. The EIS works best if you’re not involved in running or working for the business.
Trap. Ensuring that the conditions to enable EIS shares to be issued are met will probably require the company to obtain specialist help and advice. It can expect to clock up a few thousand pounds in professional fees. This needs to be factored in when considering how much cash the company needs.
Shares or just a loan
Without the EIS you aren’t entitled to tax relief for the capital you put up, whether it’s in exchange for ordinary shares or just as a loan (certain types of share, i.e. those which offer a guaranteed rate of return, are treated as a loan for tax purposes). The only difference in tax relief between ordinary shares and a loan occurs if the company fails and you lose some or all of your money. In both cases you can claim a CGT loss.
Trap. The loss will only result in a tax saving if you make capital gains in the same or a later year that would otherwise result in a CGT bill.
Tip. Where you receive shares from the company (but not when you buy them from someone else) and they fall in value you can, subject to conditions, convert the CGT loss into income tax relief. This is usually more beneficial than CGT relief (see The next step ).
Guaranteed by you
Where you guarantee a loan to a business rather than provide the cash, if you have to honour the guarantee you’ll qualify for CGT loss relief as if you had lent the money (see The next step ).
Lending to a company or standing as guarantor qualifies you for capital gains tax loss relief if it fails. This is usually less valuable than the income tax relief you can get, subject to conditions, for investing money in exchange for ordinary shares which qualify for the enterprise investment scheme.