One of your companies is struggling, but the good news is that tax rules might offer the chance of a personal tax refund which you can use to boost your business. How do you produce investment capital from trading losses?
Negligible value – recap
HMRC will tell you that, as a rule, tax consequences only ever follow a transaction. For example, if you bought an investment that lost value you can’t claim that loss for tax purposes. You must sell the investment first. However, one exception to this rule is where you subscribe for shares in a trading company and they become worth virtually nothing, or as tax law puts it, are of “negligible value”.
What is negligible value?
A tribunal considered what negligible value really meant. It turned out to be different to what HMRC thought. Mr Brown (B) had ploughed £250,000 into a software company which ran into trouble. It used his and other investors’ money to cover its losses. B claimed his shares were of negligible value and sought a tax deduction for the loss. HMRC refused, arguing that there was evidence that proved the shares had worth.
HMRC’s argument was that the company’s MD, Mr Coates, was willing to purchase more shares at a relatively high price to provide the company with enough money to stay afloat. HMRC said this reflected hope value in the company’s future. If the shares were worth that much to the MD, then they must be worth an equal value to B.
A third party view
The MD had an interest in keeping the company going because he had a great deal of money tied up in it. For this reason he was willing to stump up more cash in the hope the company would come good. The tribunal said that while the MD was willing to pay for shares, this wasn’t a true test of how much they were worth. By law the true test was whether an outsider would be willing to buy shares.
A fictional buyer
In the case of a negligible value claim the law assumes the existence of a fictional buyer who would have all the information about the company available and take a prudent view on how much the shares were worth. In this case one look at the accounts meant that realistically there was no market for the shares outside existing investors at any price, and so they had a negligible value. B was therefore entitled to claim his tax loss.
Advice. A practical use for this ruling could be to generate a tax refund which can be reinvested in the business venture that is struggling.
Example. Bill and Ben set up Acom Ltd in 2012 with £100,000. After a bright start Acom made losses and used all the money, so that overall its debts outweighed its assets. There’s no certainty of a recovery, but Bill and Ben remain upbeat. They could risk putting in more of their savings, but instead they claim that the shares have negligible value. This creates a loss which they can set against their tax bills for the same or previous year. Depending on how much tax they had paid that could generate a tax refund of up to £45,000. They invest this in Acom to give it a new lease of life.