Bear traps for business owners

10 April 2024
Keeping a business going in recent years has been a challenge with the latest statistics backing that up, showing that over a third of new businesses in the UK fail after three years. Over a five-year period, the survival rate of new businesses falls to less than 40%.

You might reasonably assume then that if someone takes on the risk of funding a new business, they might benefit from some tax relief should that business subsequently fail. In many cases, a business owner or investor may well limit their losses with some tax relief but the recently published tax case of Abigail Tan vs HMRC highlights that it is not a done deal.

There are potential pitfalls for the unwary business owner as Ms Tan found to her cost. Ms Tan was one of two shareholders in a company called Kleos (Holdings) Limited (KHL), which operated in the hospitality sector, and the case involved a claim for tax relief in respect of these shares. 

In particular, a claim for income tax relief had been submitted by Ms Tan in respect of 150,000 £1 shares held by her in KHL, on the basis they had become of “negligible value” and that the company satisfied other necessary criteria.  

A “negligible value claim” allows an owner of an asset to be treated for tax purposes as having sold and reacquired it at market value, even if they have not in fact done so. It can potentially allow for a tax loss to be triggered providing the asset is now worth next to nothing. In addition, a “negligible value claim” for shares in certain businesses can allow for a further claim to be made that allows for that loss to be used against income, rather than capital gains. That can make it a much more valuable tax relief as it could, for example, allow for tax to be saved at a rate of 45% rather than 20% for additional rate taxpayers.

A key requirement for a successful “negligible value claim” is that the asset has become worthless over time. It cannot therefore have a negligible value at the time it is acquired. This was one of the key challenges that faced Ms Tan in respect of her shares.

Initially, there were only 2 £1 shares in KHL with Ms Tan owning one of these. In funding the business, Ms Tan had provided loans to the company totalling £150,000. In September 2017, Ms Tan effectively swapped this loan for an additional 150,000 £1 shares. However, the company’s accounts showed that the business of licensed restaurants closed down soon afterwards in November 2017 and its tax computation showed that there were no chargeable profits in the period to that date, and that there were losses brought forward from earlier years. 

HMRC therefore contended that at the time Ms Tan received the shares, they were already worthless. As a result, the claim for tax relief was denied as Ms Tan had effectively converted a bad debt due to her from the company into valueless shares. Therefore, there was no opportunity for the shares to become of negligible value as they were worthless from the time of issue.

The step of converting loans to shares can sometimes be taken by business owners to remove debt from the balance sheet of a company by turning it into equity. However, as proven here, it can sometimes prove fatal for a claim for tax relief. 

Rubbing salt in the wound is that if Ms Tan had done nothing, she may have received tax relief for the original loan she had made under a different set of rules. This separate relief was considered briefly in the court but dismissed on various grounds including that there was insufficient evidence to support such a claim. This case highlights the bear traps that can await business owners, resulting in tax relief being denied, by making a seemingly innocent and commercial decision.