There are many strategies for investing in business, which have different tax consequences
There are numerous ways to invest in a business so as to both provide working capital to the business, and to receive a return on that investment as payment for the capital.
The most common forms of investment are:
The simplest investment is to loan money to the company for a fixed term. Interest is paid by the business as payment for the provision of the loan. The interest is subject to income tax for the recipient and is a tax-deductible expense for the business. A loan may be secured by a particular asset of the business (Fixed charge) or over all the assets, in general (floating charge), which gives the lender better rights of recovery in the event of insolvency.
This is similar to a loan in that a loan is made for a fixed term and a set rate of interest paid on that loan. The difference is that a debenture is a right that is registered with the company, much as for shares, and can, therefore, be bought and sold. This means that an investor can realise their investment without the loan being repaid by the company, so it gives flexibility to the investor.
For both loans and debentures, companies paying interest to individuals may be required to withhold basic rate tax on those payments and pay the withheld tax directly to HMRC, requiring quarterly returns to be made. This additional administrative burden may make loans a less attractive way of obtaining investment for companies.
Shares (Company only)
The initial funds are invested in exchange for shares, which effectively are a right to dividends and to a share of the excess capital on the winding up of the company. Dividends are paid out of profits on those shares and are subject to lower rates of tax than interest, but do not receive tax relief for the company. The shares can be bought and sold, either privately or on a recognised stock exchange. The value of the shares is dictated both by the underlying asset value of the company and the expected return (dividend) on the shares. Shareholders are not preferential creditors of the company, as they only receive distributions of capital on a winding up once all other creditors are repaid.
Preference shares are a separate type of share that offer a fixed rate of dividend, and preferential treatment in the event of a liquidation.