Jennifer Adams outlines the tax implications associated with various sources of funding for a business.
The tax implications of any source of business finance depend upon the nature of the financing and the purpose of the funds.
Each source carries distinct tax consequences that can impact a business's profitability, tax liability, and financial structure.
Personal financing
When an unincorporated business is financed using the business owner’s personal funds, there are no immediate tax implications.
However, if the business is a corporation, any personal funds used will be treated as a loan and credited to their director's Loan account, for repayment when finances allow. In this case, there are no immediate tax implications, and tax-deductible interest can generally be paid on the loan.
Government and local authority funding
Government funding can take the form of non-repayable grants, or grants with specific eligibility criteria (e.g., government-backed start up loans of £500 to £25,000).
Some local authorities and business support organisations offer grants to help cover start-up costs, training, or innovation (e.g., Elmbridge Business Boost Grants, which gives local businesses up to £2,000 to help improve their shop fronts or signage).
As the grants are non-repayable, they are considered taxable income for the business, unless specifically exempted. If the grant covers certain expenses, the business may be prohibited from claiming tax deductions for those expenses.
Bank finance
Securing a bank loan for a start-up business can be challenging, primarily because banks typically view start-ups as high-risk ventures. Most start-ups do not have a track record of financial performance, which makes it difficult for banks to assess the business’s ability to repay the loan.
Interest charged is tax-deductible, while the capital amount is recorded as a creditor on the business balance sheet.
Other finance methods
Some businesses, despite having healthy balance sheets, may lack sufficient cash to expand and need to explore alternative financing methods.
While a bank loan is often the first option, there are other tax-efficient financing avenues to consider.
Enterprise schemes
The seed enterprise investment scheme (SEIS) and enterprise investment scheme have been successful despite their restrictive conditions. Both schemes provide tax incentives to individuals investing in small, unquoted trading companies only.
For example, under the SEIS, individuals who subscribe for shares receive tax relief of 50% on the cost of the shares, offset against the individual's tax liability for the year of investment up to a limit of £250,000. Tax relief may be withheld or withdrawn if conditions are not met for three years. If the shares are sold at a loss, that loss can be offset against income for the current year and the previous year rather than against capital gains.
Outside investment
Venture capital investment is typically undertaken for larger purchases (e.g., buying a factory). Investors (either individuals or groups) are willing to invest money in a new or growing business in exchange for an agreed profit share. Such investors usually aim to exit after a number of years, having (hopefully) overseen a period of rapid growth, often requiring a place on the company's board and expecting a significant say in strategy. For the business, these funds are treated as capital in the accounts.
Crowdfunding allows investors to support businesses they find interesting, usually in exchange for early access to products—such as new or innovative technology—or small equity stakes. The advantage is that the money is not expected to be repaid nor interest charged. However, the potential downside is that the company may end up with numerous small investors, complicating future sale of the business. For the business, funds from crowdfunding are taxable revenue, and investors may incur capital gains tax upon selling their shares.
Practical tip
One area of financing but which has no guarantee of investment is business competitions, where winners can receive funding, business guidance and support but also press coverage.
