Investing in your business efficiently

When you invest your money into a business, you want this to take place as efficiently as possible.

Making use of the right reliefs, such as Entrepreneurs' Relief and the Enterprise Investment Scheme, can help you realise investment returns in the most cost-effective way. But it's also important to consider the consequences of extracting your investment from such a business in the future.

Planning in advance at all stages of an investment is essential in order to minimise tax costs and maximise your returns.

Dipan Shah

In this video Dipan Shah explains how choosing the right business structure can help maximise your businesses returns and ensure you only make public the information on your business that you're comfortable with.

View transcript

Investing tax efficiently in a privately owned business is really a question of choosing the right business structure.

There are numerous factors that affect this choice. Do you need limited liability? Does it matter that your financial statements are publicly available? Does a regulator or professional body restrict your choice of structure? Tax is just one of those factors, albeit a very important one.

The cost of funding your business can be significantly reduced if the investment qualifies for tax relief. For example:

  • Interest paid on loans taken out to fund a trading company should qualify for income tax relief
  • If a company qualifies for the Enterprise Investment Scheme, then there is potential for income tax relief on the initial investment and a capital gains tax exemption on future sale
  • Non-UK domiciled individuals can use previously untaxed offshore income and gains to fund a UK trading company without triggering a tax charge on remittance.

How the investment is structured also impacts the tax payable on a sale. Individuals owning at least 5% ordinary equity in a trading company can usually pay a reduced 10% tax on up to £10m of capital gains. For a family business, spreading the shareholding among family members could increase the total gains subject to the 10% rate.

There are a number of other tax considerations which cannot be covered in this short video. The key message, however, is that your choice of business structure is very important because it directly impacts the level of after-tax returns generated from your business.

Partnership tax changes

Draft legislation has recently been issued in respect of two areas of partnership taxation.
The first area deals with the tax treatment of certain partners of limited liability partnerships (LLPs). The changes made to the rules around taxation of partners will result in some partners of LLPs being treated, for tax purposes, as ‘salaried members’ (effectively employees).

The LLP will have a number of obligations, including withholding income tax and employee National Insurance contributions on those ‘salaried members’, costing 13.8% of the partners’ reward.
The rules are due to come into effect on 6 April 2014, although the House of Lords Economic Affairs Committee published a report on 11 March proposing that these rules should be delayed until 2015.  We recommend that all UK LLPs look closely at the conditions contained in the draft legislation, and document their findings.

The second area looks to counter the artificial allocation of profits or losses to partners.  This measure could affect all partnerships that have both individual and non-individual members (for example companies or trusts); it is not solely for LLPs.  If the conditions contained in the legislation are met, some or all of a partnership's trading profits are reallocated for tax purposes from the non-individual partners to the individual partners.  There are also rules covering any losses in a partnership, effectively denying loss relief in certain situations.  The legislation is drafted widely, and so will catch a number of mixed membership partnerships; it will apply even where the arrangements are in place for bona-fide commercial reasons.  These rules are due to come into effect on 6 April 2014, with some anti-avoidance provisions having come into force already.  We recommend that all partnerships with mixed memberships look closely at their profit and loss sharing arrangements to ascertain whether they will meet the conditions, and document their findings.

UK residential property tax changes

There have been recently announced changes in respect of high value (i.e. over £2m) UK residential property held by ‘non-natural persons’ (broadly, companies and partnerships with corporate partners). See the section on ‘Preserving your assets’ for more detail; but there are exemptions to the new measures, which need to be claimed, in respect of residential property owned for business purposes.

A review of the holding structures for these kinds of property should be considered in the light of these new rules.

Capital gains tax (CGT) – crystallising losses

You could consider crystallising your unrealised losses on poorly performing assets (unless in a close company) and reinvesting them in assets with greater growth potential. This would generate losses which could be offset against future taxable gains whilst enabling a move into assets with greater growth potential.

Reliefs and schemes available

Entrepreneurs’ Relief – capital gains tax at 10%

You’re able to pay CGT at the preferential rate of 10% on up to £10m of your business assets (if they meet the qualifying requirements). There’s also potential for your spouse and other family members to qualify for another £10m disposal if they’re involved with the business.

Using approved business investment reliefs

Maximising use of the Enterprise Investment Scheme (EIS) and new Seed EIS – aimed at start-up family businesses. These schemes provide a range of income tax and CGT benefits so it’s worth checking whether the investment qualifies.

Venture Capital Trusts

Venture Capital Trusts (VCTs) were introduced in 1995 to encourage investment in unquoted companies. Investors who wish to support new and expanding companies but do not wish to do so directly, can obtain tax reliefs by investing in shares in VCTs, which hold a portfolio of shares and securities in qualifying companies. The main tax reliefs arising for an individual's subscription for shares in a VCT are income tax relief at 30% on amounts subscribed up to a maximum of £200,000 in a tax year; tax free treatment of Dividends received from VCT investments; and an exemption from capital gains tax on disposal of VCT shares.  Shares need to be held for at least 5 years.

Enterprise Investment Scheme

The Enterprise Investment Scheme (EIS) was established by the 1994 Finance Act for shares issued on or after 1 January 1994. It is designed to stimulate investment in unquoted companies. The main tax reliefs for individuals investing in EIS qualifying shares are a 30% up front income tax relief (on an investments of up to £1m in any tax year), a capital gains tax exemption on disposal of EIS qualifying shares, generous loss relief on disposal of shares, and a potential capital gains deferral relief. Shares need to be held for at least 3 years.

Seed Enterprise Investment Scheme

The Seed Enterprise Investment Scheme (SEIS) is closely based on the Enterprise Investment Scheme, and was introduced in 2012 to incentivise investors in high risk, early stage businesses through the use of generous tax reliefs. The scheme specifically provides individuals up front income tax relief at 50% in respect of a subscription of qualifying SEIS shares (on investments of up to £100,000 in any tax year) in a qualifying SEIS company, a full capital gains exemption on disposal of qualifying shares, and relief for losses. For 2013/14, there is also the opportunity to obtain relief on capital gains reinvested in SEIS companies. Shares need to be held for at least 3 years.

Incentivise key employees tax efficiently to drive growth

There are a range of tax efficient employee share schemes that can be used to incentivise employees in family business to drive value growth.  Each scheme has different conditions and is targeted at companies in different stages of their life cycle.

Transferring family business assets to the next generation

Consider inheritance tax (IHT) planning prior to the sale of a business – as this point is an excellent opportunity to transfer assets within your family tax efficiently and ensure family members are provided for.

Choosing the right business structure

If you run your own business, you should be aware there are a range of business structures possible in the UK with very different tax attributes for the owners. Getting the right structure for you and your business can help save considerable amounts over the long term.

For example privately owned companies must consider both tax paid at company level and tax paid by the shareholder. For a property rental business run in a company, where profits are reinvested, the effective tax rate on profits is 23% (21% from April 2014). But if profits are withdrawn, the effective tax rate is up to 47% (45% from April 2014). In comparison, if the rental business was run in a partnership, the effective tax rate on ongoing profits would be up to 45%, irrespective of whether profits are reinvested.