Capital contributions

What are they and how are they taxed?

Typically, in the UK we fund companies either by debt or equity; in other words, subscribing for shares or lending money to an entity.

Many overseas jurisdictions use capital contributions as an alternate method to fund subsidiaries, and we are increasingly seeing US parent entities funding its UK subsidiaries by this method particularly where a subsidiary has run into financial difficulties and has limited borrowing capacity.

A UK peculiarity

While many overseas jurisdictions recognise capital contributions in their legal framework, they are somewhat of a peculiarity in the UK and are not specifically recognised in our UK legal or tax codes. As a result, it raises the question as to how a UK company receiving a capital contribution should treat the receipt from a UK tax perspective. It is often assumed a capital contribution is a gift that should be tax free in the hands of the recipient. However, there is a risk that the receipt is taxable depending on the facts and circumstances.

Judicial consideration and tax risk

Given the lack of legislation on this point, it is not surprising there have been several cases heard in the UK Courts assessing whether the contribution is income or capital and taxable. As highlighted in Commissioners of Inland Revenue v Falkirk Ice Rink Ltd (1975), the risk of the contribution being taxable as a trading receipt is heightened where the receiving company is trading, as the contribution could be seen as meeting the company’s trading expenses. In addition, where there are numerous capital contributions rather than a one-off payment, this could lead the receipt being viewed as income rather than capital. Carefully documenting the intention and use of the capital contribution is clearly important.

It is worth noting that even where the contribution is accounted for in reserves without hitting the current year profit and loss account this does not mean the receipt is not taxable. Indeed, where the facts of the case indicate a trading receipt, the UK courts are prepared to override the accounting treatment where they consider it appropriate to do so.

What next?

In summary, this is a complex area not helped by the lack of authority in the UK legal and tax legislative frameworks. Each case is fact specific, and it is important businesses seek tax advice before implementing such a funding arrangement in the UK to avoid an unexpected tax liability.

For further information on anything discussed in this article, or how we can help you, please contact your usual Crowe contact.