Family loan to me or to my company? What's better for tax?

[SunnySpring]

Consider the following simplified scenario:

So, hurray!, I got an amount of money "A" from my family/friends as an interest free loan. They have paid tax on the money before they give it to me.

I decide to spent this money on my living costs and development costs for a product I am building. In that time, possibly several years, I will have no income or earnings, just living of "A", while working to built up my clever thing.

When the product is completed, for simplicity, let's say it sells in a single outright transaction for an amount "B" and let's say it's enough to pay amount "A" back to my family/friends.

Question (1) Do I get into trouble if I do not register as a sole trader and/or do self-assessment while I am doing my development work? Obviously I have no taxable income, just living off money which my family/friends already got taxed for (taxed at source!) - so there should be no tax liability, and therefore no point in having to do personal tax returns in this time before the sale?

Question (2) After the sale, money B comes into my personal account, I register to do my taxes. I will transfer money "A" back to my family/friends. I will only have to pay personal income tax on C=B-A ? not the total income B, correct? Does anyone know the relevant HMRC online link which proves that loan-payback can be taken off taxable income ?

Question (3) Assume amount C is substantial - is there really a tax advantage of doing my project as a limited company? I know if I do everything the way I am saying, with minimal admin I just suddenly end up with a large sum of money in my personal account and I will end up having to pay in the highest tax band, 45%.

But I have a feeling there is no way to get significantly below this, short of emigrating and doing it all in a tax haven, because doing it all through a company would look like this (correct me if I am wrong please):

My family/friends would pay the amount "A" as a loan to the company. The company takes it to cover the expenses "A" for the development of the product and writes a loss of "A" in the time of the development (as nothing else is happening in the company).

Then the sale happens and income "B" comes in, C=B-A is the profit, which will be taxed at 20% corporation tax, so I end up with D=C*0.8 sitting in the company account. Now if I take "D" out of the company, I will have to pay 45% on top of the 20% tax already paid and end up with less than in the case where I saved myself the whole trouble of setting up a company, doing company tax returns etc.

Am I missing something or is there really no point in doing things through a company in this special scenario?

I am very thankful for any comments/explanations.

 

[Ian J]

Wow, you've made that very complicated with all your As and Bs etc

You only pay tax whether Corporation or Income Tax on profits and loans don't effect profits at all as it's just income minus costs

 

[Chris Ashdown]

Why do you need 2 to 3 years to develop something, why not make a working sample and then get investors, money from friends and family is a well proven method to fall out with them when there needs change
Can you not work and do the research etc in your spare time

 

[mattk]

Q1 - No. The loan/gift is not classed as income, so you don't have to pay tax on it.

Q2 - No, the loan from your family is not tax deducible on a personal level. If it was, everyone would be lending each other money and claiming the tax back.

Q3 - There are no real tax advantages to working within a limited company compared to self-employed. The main benefit is limited liability.

If your family loaned money to your company, then yes, it is tax deducible when it is paid back. However, that loan can only be used for business expenses, not your personal living costs. If you use it for living expenses then you incur an income tax liability.

Couple of other points, Corporation Tax is 19% and if your company makes a profit you can pay yourself a dividend which is taxed at 7.5%, 32.5% or 38.1%.

My advice would be to focus on developing your product rather than worrying about structuring your company in the most tax efficient way.

 

[SunnySpring]

Thanks for your answers, things make more sense now. Mattk: I am not too worried about structuring for tax, I just want to avoid making a BIG mistake regarding tax!

I see now that not properly accounting for business expenses could be such a big mistake?

If I develop just in private and blow my families/friends money on expenses for building the product, not telling the HMRC about these expenses for a few years and then suddenly get money from a sale - can I (or a proper accountant, who I can then afford) still get HMRC to accept these expenses in retrospect? Assuming I have receipts and explanations how these expenses where necessary for the research and development - Or does the HMRC have a time limit on this?

 

[mattk]

Expenses are only accountable in that tax year. However, if you make a loss (as you are incurring expenses, but no income) that loss can be offset against future profits.

You have to make sure the expenses are genuine businesses costs, not just living expenses.

Have you read The Lean Startup? Nothing should take "several years" to develop before you are generating an income. You should build a Minimum Viable Product in order to test your outcome hypothesis before committing months, let alone years, to developing an all-singing, all-dancing product.

 

[NickGrogan]

When the product is completed, for simplicity, let's say it sells in a single outright transaction for an amount "B" and let's say it's enough to pay amount "A" back to my family/friends.

Rather than worry about the tax, you'd do better to worry about making this happen.

How many products have you made and sold successfully?

 

[Financial-Modeller]

@SunnySpring what stage are you at today?

Is this just an idea, or have you borrowed funds and are currently in development, or have you developed the "clever thing", or have you received funds from the "clever thing" and no looking to minimise tax retrospectively?

 

[DWS]

You can claim expenses going back 7 years before you start your business providing they would have been tax-deductible if you had incurred them whilst trading, these pre trading expenses should be treated as an expense on the first day that the business commences

 

[JCresswellTax]

Consider the following simplified scenario:

So, hurray!, I got an amount of money "A" from my family/friends as an interest free loan. They have paid tax on the money before they give it to me.

I decide to spent this money on my living costs and development costs for a product I am building. In that time, possibly several years, I will have no income or earnings, just living of "A", while working to built up my clever thing.

When the product is completed, for simplicity, let's say it sells in a single outright transaction for an amount "B" and let's say it's enough to pay amount "A" back to my family/friends.

Question (1) Do I get into trouble if I do not register as a sole trader and/or do self-assessment while I am doing my development work? Obviously I have no taxable income, just living off money which my family/friends already got taxed for (taxed at source!) - so there should be no tax liability, and therefore no point in having to do personal tax returns in this time before the sale?

Question (2) After the sale, money B comes into my personal account, I register to do my taxes. I will transfer money "A" back to my family/friends. I will only have to pay personal income tax on C=B-A ? not the total income B, correct? Does anyone know the relevant HMRC online link which proves that loan-payback can be taken off taxable income ?

Question (3) Assume amount C is substantial - is there really a tax advantage of doing my project as a limited company? I know if I do everything the way I am saying, with minimal admin I just suddenly end up with a large sum of money in my personal account and I will end up having to pay in the highest tax band, 45%.

But I have a feeling there is no way to get significantly below this, short of emigrating and doing it all in a tax haven, because doing it all through a company would look like this (correct me if I am wrong please):

My family/friends would pay the amount "A" as a loan to the company. The company takes it to cover the expenses "A" for the development of the product and writes a loss of "A" in the time of the development (as nothing else is happening in the company).

Then the sale happens and income "B" comes in, C=B-A is the profit, which will be taxed at 20% corporation tax, so I end up with D=C*0.8 sitting in the company account. Now if I take "D" out of the company, I will have to pay 45% on top of the 20% tax already paid and end up with less than in the case where I saved myself the whole trouble of setting up a company, doing company tax returns etc.

Am I missing something or is there really no point in doing things through a company in this special scenario?

I am very thankful for any comments/explanations.

Jesus man

 

[DontAsk]

Q3 - There are no real tax advantages to working within a limited company compared to self-employed. The main benefit is limited liability.

Really? A whole lot of people must be getting it wrong in that case.

 

[SteveHa]

Loan repayments are not taxable, only the interest on those loans, and since they are interest free, the whole of your profit is taxable.

If you register as a limited company and the money is loaned directly to the company, and then you use some of that money for personal expenses, you create a separate transaction which will represent either a loan to you subject to S.455 tax and, possibly, a benefit in kind, or income subject to income tax.

You need an accountant to work through the whole quagmire.