THE lifeblood of a business is capital. Some businesses may have the option of looking to a more successful affiliate for capital injection. In this instance, there is often more flexibility in terms of the options available.

There are some practical considerations which affect the cost of capital to a business and should be taken into account when determining the structure used to infuse capital into a business, which may be done by taking a loan or an equity investment. It is not possible to say in isolation and as a general statement that one option is more advantageous than the other. I recommend that specific consultation with an attorney-at-law or an accountant be done in determining the most appropriate approach.

In the meanwhile, the following points may be considered:

(1) Interest payment on loans would be a deductible expense in the profit and loss account of the borrower, and this would have the effect of reducing the amount of taxes payable.

(2) Interest payments would create a fixed liability on the borrower, and so the lender would have little difficulty justifying its entitlement to payments from its affiliate, which is sometimes a subsidiary. Dividends on ordinary shares are payable only when the company reports distributable profit and has declared a dividend.

(3) Quasi-debt instruments in the form of cumulative preference shares may also be considered. Cumulative preference shares may indicate that a fixed rate of return is due to the shareholder and during periods when the company does not report any distributable profit, the dividend on these preference shares will accumulate as a company debt. Dividends on preference shares may also be deductible as an expense of the borrower. Preference shares may also be redeemable, which has the effect of allowing a shareholder to recoup his principal investment, if the conditions specified by the Companies Act for redemption of shares are satisfied at the time of the redemption.

(4) Investing by means of a loan would also create a fixed obligation on the borrower to repay the principal. The circumstances under which shares may be redeemed are stricter than for the repayment of loan principal.

(5) Investing equity may have other practical advantages for the company in need of capital, particularly those advantages which are associated with having a well- capitalised company versus one which is highly leveraged.

(6) If there are loan documents, stamp duty is payable. The amount of stamp duty will depend on the type of documents, particularly whether there are security documents involved in this transaction. There are no taxes payable on the allotment of shares to a person injecting equity into a company.

(7) The rate of income tax on dividends paid to Jamaican holders of ordinary shares is zero per cent. Interest income (which would be derived from a loan) is taxable at 33 1/3 per cent when paid to companies.

(8) The lender has to ensure that the capital injection transaction does not fall afoul of the laws restricting the circumstances under which a company may provide financial assistance to another company.

It is advisable for businesses to ensure that the capital injection transaction is structured in the most efficient way possible, having regard to the various legal and accounting considerations. It is usually sound advice for a business to keep the cost of capital as low as possible to ensure that more resources are available to fund operations and profit distribution.

Andrea Scarlett-Lozer is an Associate at Myers, Fletcher & Gordon and is a member of the firm’s Commercial and Intellectual Property Departments. Andrea may be contacted via www.myersfletcher.com or 922-5860.