I am the sole-Director of a Spanish S.L. (somewhat similar to a UK Ltd.) that is building a Software-as-a-Service solution for property owners. We are still in the development phase and have no paying customers yet.
The Spanish S.L. was incorporated in December 2014 and I was its main shareholder (with a 98% stake) until July 2015, when it carried out a capital increase.
Back then, the company applied to a Spanish public loan (which in the end it didn't even get!) whose amount was capped to the applicant's shareholders' equity. That was the main reason why we had to increase the capital of the S.L..
Back then, we (shareholders') had the option to increase the S.L. capital by making make an in-kind contribution (by capitalising the software that we were developing) but that would have been a too long and costly process, as it required a certified third party valuation of the software. And the software development, by the way, hasn't finished yet.
We finally opted for the following solution, that was "suggested" by a Spanish public notary, the same one who later certified and registered the capital increase (it has to go through a public notary here in Spain, which is quite of a bureaucratic and costly procedure):
1. in June 2015 I incorporated a UK Ltd. with a minimum capital of GBP 1.00 (100 shares of nominal value of 1p) being the sole-Director of it
2. on July, 1st the UK Ltd. "sold" a software to the Spanish S.L. for EUR 114,000. Please note that in Spain they don't care how this piece of sotware got into the Ltd. (it could have been developed in house, purchased or contributed by a shareholder, etc.)
3. the Spanish S.L. had not enough cash to pay for the Ltd. invoice and "offered" the Ltd. to convert that debt into equity for the same exact amount. The "offer" was ultimately "accepted".
4. At the end of July 2015 we made a capital increase of EUR 150,000 by converting debts into equity. The debt were:
More recently I was talking about it with a friend of mine, who works as tax advisor in Italy. This guy pointed my attention to a couple of issues I didn't think of and strongly adviced me to talk to someone who is knowledgeable about Spain/UK. In his opinion, the main issues that arise from the way we structured the deal are:
a) a cost of ~EUR 114k for the Spanish S.L. that despite it was capitalised, it can still be inquired / challenged by tax authorities
b) a net profit of ~EUR 114k for the UK Ltd.
Now I am not too much concerned about a) as we are a tech startup and expect to be either successful or not to be around within a couple of years. That said, even if we will ultimately be challenge the software cost and lose any related "carried forward loss".. it won't be a big deal! If fact, at that point if the business will be successful we will pay more taxes (fine!) or alternatively the company will be shutted down irrespective of that tax loss. Anyway, nevermind! I admit this is a too pragmatic / simplistic approach and I will be further discussing the matter with a local Spanish accountant, when we will be hiring one to help us with the 2015 accounts.
What I am now looking for is a solution to b) as our intention was to not generate any profit in the UK (and have no money to pay taxes on it anyway!). We just wanted to use a UK vehicle to speed up our capital increase in Spain and at the same time having an "holding" company in the UK that we could use to raise some additional capital, as most international investors rather prefer to invest under the UK rather than the Spanish laws.
The good news is that the Spanish public notary did not request us to show him the UK Ltd. invoice, so we still have some flexibility about its content. A few other points you might want to take into consideration:
1. That EUR 114k sale was VAT-free, being it below the GBP 82k VAT threshold (https://www.gov.uk/vat-registration-thresholds).
2. Being the software still under development, so we can consider it a pre-payment (I mean, the client paid it all in advance and is getting shipped new versions of the software on a quarterly basis).
3. After the capital increase, the Spanish Ltd shareholders are:
the UK Ltd (75.02%)myself (24.94%)Mr. X (0.02%)Mr. Y (0.02%)
If possible, I would like to keep my direct stake into the S.L. < 25%
Yesterday I came up with a possible solution which it's quite creative, I have to admit that!
1. The software sold on July, 1st to the S.L. was purchased a week before for ~EUR 114k from the actual developer (self-employed, based in Russia).
2. I assume NO VAT arose from that invoice and also it doesn't count for the VAT threshold. In other words, after the Ltd. re-sells the software, it doesn't have to apply for a VAT registration number (as we didn't request it neither plan to need it in the future, being the Ltd. a pure "holding" now, with no operations ongoing)
3. The debt arising from the developer's invoice is later converted into an option to subscribe a capital increase. By doing so 1) we don't keep the unpaid invoice outstanding for too long and 2) it makes business sense for the developer too, who is not "working without getting paid" but he is actually contributing "as a partner" although he will become an actual shareholder ONLY after converting hei option, which is something he will do ONLY if the business picks up and will be financially rewarding for him to do so. This is the reason why back in June we agreed the terms and decided to setup an "holding" company in the UK (our Ltd.) and do the transaction via a UK company, as the developer was not comfortable to hold an option / invest into a Spanish company. Please consider that to be able to invest into a Spanish entity you need to get a local tax number (costly and lenghty procedure, especially if you are not from the EU / can't travel to Spain) and all shares transactions will have to be registered through a public notery (again, additional traveling and legal representation costs!).
4. At the end of the fiscal year, the Ltd. has a balance sheet somehow similar to:
ASSETS
stake into the Spanish S.L. for GBP XXX,XXX
LIABILITIES
Equity for GBP 1.00
Equity call option for GBP XXX,XXX - 1.00
and a P&L close to 0.
OUTCOME of the proposed solution:
1. No taxes are due by the Ltd. (as income for the year will be close to 0)
2. No VAT registration / return needed
3. the day the developer will exercise the option, the Ltd. will increase its capital and will file that with the Companies House. If not, no other filings are due in the meantime.
A second possible solution I was thinking about is about make an impairment of the stake the Ltd. owns into the S.L. when closing the UK books in April 2016. The loss arising from the impairment will partially offset the gain of the sale. I will end up with let's say 10k profit for the year and will pay 2k in corporate tax. However, I am not sure that would work. In fact, at least in Italy, the devaluation of a controlling stake has no fiscal benefit.
A third possible solution would be to sell part of that 75.02% stake to a third party, at a much lower valuation and by doing so having a transaction to "support" the case for an asset impairment. However, that might not work or (worse) it can raise further issues as someone might challenge its rationale. Someone might ask WHY the Ltd. is "purchasing" a stake into an S.L. and selling part of it with a huge loss, all within the same financial year! My answer would be that we are talking about an early stage business, where valuation can be anything between 0 and a couple of millions, depending on the market expectations, etc. After 1 year we realized that wonderful idea is almost unachievable... and therefore almost valueless.
In the ultimate case there is no way to avoid paying substantial taxes in the UK at the end of current tax year (and on something we didn't actually sold yet!), I would rather prefer to be the gains related to me rather than the UK Ltd. and possibly "capital gains" rather than "self-employment related income". I am not resident in the UK and I have former capital losses in Spain that I should be able to use to partially offset those gains.
The Spanish S.L. was incorporated in December 2014 and I was its main shareholder (with a 98% stake) until July 2015, when it carried out a capital increase.
Back then, the company applied to a Spanish public loan (which in the end it didn't even get!) whose amount was capped to the applicant's shareholders' equity. That was the main reason why we had to increase the capital of the S.L..
Back then, we (shareholders') had the option to increase the S.L. capital by making make an in-kind contribution (by capitalising the software that we were developing) but that would have been a too long and costly process, as it required a certified third party valuation of the software. And the software development, by the way, hasn't finished yet.
We finally opted for the following solution, that was "suggested" by a Spanish public notary, the same one who later certified and registered the capital increase (it has to go through a public notary here in Spain, which is quite of a bureaucratic and costly procedure):
1. in June 2015 I incorporated a UK Ltd. with a minimum capital of GBP 1.00 (100 shares of nominal value of 1p) being the sole-Director of it
2. on July, 1st the UK Ltd. "sold" a software to the Spanish S.L. for EUR 114,000. Please note that in Spain they don't care how this piece of sotware got into the Ltd. (it could have been developed in house, purchased or contributed by a shareholder, etc.)
3. the Spanish S.L. had not enough cash to pay for the Ltd. invoice and "offered" the Ltd. to convert that debt into equity for the same exact amount. The "offer" was ultimately "accepted".
4. At the end of July 2015 we made a capital increase of EUR 150,000 by converting debts into equity. The debt were:
a) the UK Ltd.'s invoice (114k)
b) an unpaid invoice of mine for professional services I gave to the S.L. (10k)
c) a shareholders' loan (money I lent to the Spanish S.L. during the first half of 2015) (36k)
Back then, we didn't discuss the above operation with any accountant (neither in Spain of the UK) as we were too much focused on developing the business and looking for financing.b) an unpaid invoice of mine for professional services I gave to the S.L. (10k)
c) a shareholders' loan (money I lent to the Spanish S.L. during the first half of 2015) (36k)
More recently I was talking about it with a friend of mine, who works as tax advisor in Italy. This guy pointed my attention to a couple of issues I didn't think of and strongly adviced me to talk to someone who is knowledgeable about Spain/UK. In his opinion, the main issues that arise from the way we structured the deal are:
a) a cost of ~EUR 114k for the Spanish S.L. that despite it was capitalised, it can still be inquired / challenged by tax authorities
b) a net profit of ~EUR 114k for the UK Ltd.
Now I am not too much concerned about a) as we are a tech startup and expect to be either successful or not to be around within a couple of years. That said, even if we will ultimately be challenge the software cost and lose any related "carried forward loss".. it won't be a big deal! If fact, at that point if the business will be successful we will pay more taxes (fine!) or alternatively the company will be shutted down irrespective of that tax loss. Anyway, nevermind! I admit this is a too pragmatic / simplistic approach and I will be further discussing the matter with a local Spanish accountant, when we will be hiring one to help us with the 2015 accounts.
What I am now looking for is a solution to b) as our intention was to not generate any profit in the UK (and have no money to pay taxes on it anyway!). We just wanted to use a UK vehicle to speed up our capital increase in Spain and at the same time having an "holding" company in the UK that we could use to raise some additional capital, as most international investors rather prefer to invest under the UK rather than the Spanish laws.
The good news is that the Spanish public notary did not request us to show him the UK Ltd. invoice, so we still have some flexibility about its content. A few other points you might want to take into consideration:
1. That EUR 114k sale was VAT-free, being it below the GBP 82k VAT threshold (https://www.gov.uk/vat-registration-thresholds).
2. Being the software still under development, so we can consider it a pre-payment (I mean, the client paid it all in advance and is getting shipped new versions of the software on a quarterly basis).
3. After the capital increase, the Spanish Ltd shareholders are:
the UK Ltd (75.02%)myself (24.94%)Mr. X (0.02%)Mr. Y (0.02%)
If possible, I would like to keep my direct stake into the S.L. < 25%
Yesterday I came up with a possible solution which it's quite creative, I have to admit that!
1. The software sold on July, 1st to the S.L. was purchased a week before for ~EUR 114k from the actual developer (self-employed, based in Russia).
2. I assume NO VAT arose from that invoice and also it doesn't count for the VAT threshold. In other words, after the Ltd. re-sells the software, it doesn't have to apply for a VAT registration number (as we didn't request it neither plan to need it in the future, being the Ltd. a pure "holding" now, with no operations ongoing)
3. The debt arising from the developer's invoice is later converted into an option to subscribe a capital increase. By doing so 1) we don't keep the unpaid invoice outstanding for too long and 2) it makes business sense for the developer too, who is not "working without getting paid" but he is actually contributing "as a partner" although he will become an actual shareholder ONLY after converting hei option, which is something he will do ONLY if the business picks up and will be financially rewarding for him to do so. This is the reason why back in June we agreed the terms and decided to setup an "holding" company in the UK (our Ltd.) and do the transaction via a UK company, as the developer was not comfortable to hold an option / invest into a Spanish company. Please consider that to be able to invest into a Spanish entity you need to get a local tax number (costly and lenghty procedure, especially if you are not from the EU / can't travel to Spain) and all shares transactions will have to be registered through a public notery (again, additional traveling and legal representation costs!).
4. At the end of the fiscal year, the Ltd. has a balance sheet somehow similar to:
ASSETS
stake into the Spanish S.L. for GBP XXX,XXX
LIABILITIES
Equity for GBP 1.00
Equity call option for GBP XXX,XXX - 1.00
and a P&L close to 0.
OUTCOME of the proposed solution:
1. No taxes are due by the Ltd. (as income for the year will be close to 0)
2. No VAT registration / return needed
3. the day the developer will exercise the option, the Ltd. will increase its capital and will file that with the Companies House. If not, no other filings are due in the meantime.
A second possible solution I was thinking about is about make an impairment of the stake the Ltd. owns into the S.L. when closing the UK books in April 2016. The loss arising from the impairment will partially offset the gain of the sale. I will end up with let's say 10k profit for the year and will pay 2k in corporate tax. However, I am not sure that would work. In fact, at least in Italy, the devaluation of a controlling stake has no fiscal benefit.
A third possible solution would be to sell part of that 75.02% stake to a third party, at a much lower valuation and by doing so having a transaction to "support" the case for an asset impairment. However, that might not work or (worse) it can raise further issues as someone might challenge its rationale. Someone might ask WHY the Ltd. is "purchasing" a stake into an S.L. and selling part of it with a huge loss, all within the same financial year! My answer would be that we are talking about an early stage business, where valuation can be anything between 0 and a couple of millions, depending on the market expectations, etc. After 1 year we realized that wonderful idea is almost unachievable... and therefore almost valueless.
In the ultimate case there is no way to avoid paying substantial taxes in the UK at the end of current tax year (and on something we didn't actually sold yet!), I would rather prefer to be the gains related to me rather than the UK Ltd. and possibly "capital gains" rather than "self-employment related income". I am not resident in the UK and I have former capital losses in Spain that I should be able to use to partially offset those gains.