Back in summer 2024, Graeme Robb from the M&G Wealth technical team, considered investment options for companies holding surplus cash on their balance sheets. Here, he looks at a further five points to consider.
It’s not uncommon for companies to invest into onshore and offshore insurance bond wrappers to access funds offering the prospect of low volatility and smoothed returns which you can’t get in an OEIC. That smoothing can be important to protect the directors from short term volatility and provide them with peace of mind in the knowledge that the funds will be needed at some point for business purposes – i.e. new premises, new plant & equipment, increased headcount, pay off debt, reward directors, employer pension contributions and so on.
That article dealt with five common questions and answers regarding company investment.
- How is an investment bond taxed inside a company?
- What is a micro entity?
- How does a micro entity account for an insurance bond?
- How does a larger, non-micro company account for an Insurance Bond?
- If a company invests onshore, does the onshore bond ‘tax credit’ apply?
This time around, Graeme considers a further five common questions and answers concerning company investment.
6. How are investment bonds set up?
The company will be the applicant/owner.
A life assurance bond requires a life/lives assured – typically directors whose death would cause financial detriment to the company.
Example of an onshore bond application
Alphabet Ltd is a trading company with four directors – A, B, C and D. The bond owner will be Alphabet Ltd with A and B (for example) chosen as lives assured. Being a life assured conveys no ownership rights and if A or B leave the company, there is no insurable interest impact since that only needs satisfied at inception.
A non-trading, investment company might not be able to demonstrate insurable interest and therefore an offshore capital redemption bond requiring no lives assured could instead be used if considered necessary.
7. Is there a simple comparison of a micro entity investing in an onshore bond versus an offshore bond?
For a micro entity using historic cost accounting, no annual gain (or loss) is recognised in the accounts, meaning no corporation tax consequences arise regardless of onshore or offshore until such time as a disposal event occurs (for example a full or part surrender).
When there is a ‘disposal event’ there is however a difference. With an onshore bond, the gain is grossed up at 100/80 to reflect the 20% credit. The gross amount is taxed at the prevailing corporation tax rate with the 20% tax credit available to offset against that.
With an offshore bond, because the company has enjoyed ‘gross roll-up’ then that gain will not be grossed up and the company will pay corporation tax at the appropriate rate on the gain.
8. Is there a simple comparison of a fair value company investing onshore versus an offshore bond?
Onshore and offshore bond annual increases in value are taxable despite the underlying life fund with an onshore bond being subject to tax.
The ‘tax credit’ with a UK bond doesn’t apply on those annual increases but does apply on a subsequent final event. Effectively therefore, double taxation initially occurs on those annual onshore bond increases i.e. life fund tax and corporation tax paid by the company on that net return.
That ‘anomaly’ is corrected on a disposal event where relief is given for those earlier credits but it should be noted that the 20% ‘tax credit’ can only be offset against the company’s overall corporation tax liability for the accounting period in question.
If the ‘tax credit’ exceeds the company’s overall corporation tax liability then the excess is not repayable and neither can it be set off against any prior or future accounting periods.
For a company which encashes the bond in an accounting period in which there are no other profits and no corporation tax liability, the full benefit of that tax credit might be lost.
Therefore, for directors of those ‘fair value’ companies concerned about ‘fluctuating’ results and potentially wasting a ‘tax credit’ in the accounting period of a future disposal, an offshore bond may be the solution. The investing company simply pays tax annually on a gross return (i.e. gross roll-up within the fund) with no tax credit on disposal.
9. Could an investment of surplus cash impact on the availability of Business Relief for inheritance tax?
For shareholders in private companies which are not wholly or mainly carrying on investment activities, then Business Relief for inheritance tax can give 100% relief from IHT.
Tax rules however prevent shareholders getting relief for non-business assets and so, the value of ‘excepted assets’ is ignored when calculating inheritance tax relief.
Surplus cash can be an excepted asset if it hasn’t been used wholly or mainly for business purposes throughout the two years prior to the transfer of value. Or, it’s not required for a palpable future business use.
Pointers on excess cash
• Only the value of excepted assets is omitted – the remaining value (assets) can get Business Relief
• Excess cash is as much an ‘excepted asset’ as an investment – so switching from cash to investment bond (or vice versa) shouldn’t impact the relief.
• Availability of BPR is only ‘tested’ on a transfer (e.g. death). Spouse/civil partner exemption might be available.
• Investments can potentially remain suitable in the medium to long term, and be distributed, perhaps by way of dividend, before an IHT ‘event’ occurs.
10. Could an investment of surplus cash impact on the availability of CGT Business Asset Disposal Relief (BADR)?
BADR which was formerly known as Entrepreneurs’ Relief can deliver a Capital Gains Tax rate of just 10% for directors selling shares in a trading company. Tax law defines a ‘trading company’ as one which doesn’t carry on non-trading activities to a substantial extent. HMRC consider ‘substantial’ in this context means more than 20%. Therefore, for BADR to be potentially available, non-trading activities must be no more than 20% of total activities. Measures or indicators should be considered.
For example:
- Income from non-trading activities.
- Time spent by directors looking after investment activities.
- The company’s asset base.
These indicators are not individual tests, but should be applied “in the round”. However, in the context of a bond for example, the “asset base” test (alone) might be conclusive since it is non-income producing and doesn’t use up directors’ time like a property letting portfolio for example might do so.
As a rule of thumb, investing will not count as a trading activity albeit that the short-term lodgement of surplus funds, for example in a deposit account, could count as a trading activity. In saying that, the long-term retention of significant earnings generated from trading activities may amount to an investment.
For business owners contemplating a disposal of shares, the accountant should carefully monitor compliance with the 80/20 split so as not to risk losing relief. In many cases however, the surplus cash balance sits comfortably within that 20% limit meaning no impact on the relief. The qualifying conditions must be satisfied for at least two years before disposal.
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