If you’re contemplating lending money to, or investing in shares of, an unquoted trading company, there’s always a risk of losing your investment, as with many investments. However, there’s potential tax relief for the lender if certain conditions are met, particularly if the loan is used entirely for the company’s trade purposes and not for money lending.

Capital Loss on Shares in an Unquoted Trading Company

This relief comes in the form of a capital loss that can offset gains in the same or future tax years. To claim this relief, the principal amount of the loan must have become irrecoverable, the claimant must retain the right to recover that amount, and there should be no spousal or civil partnership relationship between the claimant and the borrower when the loan was made or afterward.

Converting Loans into Shares

When an individual subscribes to a new share issue in an unquoted trading company and later disposes of those shares at a loss, including if the shares become worthless, a more generous loss relief is available. This involves making a negligible value claim, which triggers a deemed disposal and reacquisition of the shares at a low value, resulting in a capital loss. This loss can then be set against the subscriber’s income in the year of the loss and/or the previous year, potentially saving tax at higher rates than capital gains tax.

If a lender experiences a loss on a loan to an unquoted trading company, relief for that loss may be claimed against capital gains, while losses on subscriber shares can be set against income, providing tax savings at higher rates. The lender can also be issued shares in the company instead of repayment, potentially enabling relief for subsequent losses against their income. However, if the company is insolvent when shares are issued, no capital loss will arise, and HMRC may challenge the loss claim.

Tax Relief under the Enterprise Investment Scheme (EIS)

Under the Enterprise Investment Scheme (EIS) or Seed EIS, subscribers to qualifying companies may be eligible for even more generous tax reliefs. Investors not connected with the company can receive tax relief equivalent to 30% of the amount invested (EIS) or 50% in the case of Seed EIS, deducted from their income tax liability for the year or the previous year in the case of EIS investment. These shares must be held for at least 3 years to retain the income tax relief, and when disposed of, they are also exempt from CGT. Any resulting capital loss (net of income tax relief given) can be set against the investor’s income as outlined above.