Have you encountered the loan relationship rules? For those who haven’t advised on a company investment scenario then probably not. However, for those who have, these loan relationship rules are very important. Graeme Robb of The M&G technical team explains what they are and how they work.
First, let’s set the scene…
Surplus cash
ABC Limited is holding cash on its balance sheet surplus to working capital requirements. This surplus may be earmarked to fund a future business project or it may simply be a cash buffer to help weather the economic climate. The accountant has prepared the accounts reflecting those surplus funds. The financial adviser’s role is to advise on how those surplus funds might be better invested. Conscious that the funds will be needed at some point for business purposes, the directors opt for an insurance bond (onshore or offshore where they can enjoy multi asset investments with a smoothing process to protect them from short term volatility). They will not benefit from the full upside of any stock market rises, but crucially they will not suffer from the full effects of any downsides. This peace of mind can be invaluable.
How is that company owned bond taxed?
The normal bond chargeable event rules do not apply to companies i.e. 5% tax deferred withdrawals etc. No need to worry therefore about choosing to encash segments versus withdrawals across the segments.
The loan relationship rules
It is taxed under the loan relationship rules, the remit of which extends well beyond insurance bonds. Although complex in nature, these rules require the taxation treatment of the item in question (in this case an insurance bond) to follow the accounting treatment. To understand the tax treatment of a corporate owned investment bond, it is therefore necessary to consider the accounting treatment. There are a number of accounting standards that a company might use – principally historic cost and fair value.
Historic cost accounting
The bond is simply shown in the balance sheet at the end of the company’s accounting period at the original premium amount, regardless of the actual surrender value. No annual gain (or loss) is recognised in the company accounts, meaning no corporation tax consequences arise. The company achieves tax deferral until there is a disposal event such as full surrender, partial surrender or death of last life assured.
Fair value accounting
The balance sheet at the end of the accounting period will include the bond at its surrender value at that date. That means the movement in value (either a gain or loss) has been processed through the profit and loss account. That movement has corporation tax consequences. The company does not achieve tax deferral since the increase in value will be subject to corporation tax (any decrease is potentially relievable for corporation tax purposes).
Historic cost v fair value
Micro entities’ can use historic cost accounting for insurance bonds. Larger companies use fair value rules. A micro entity is a very small company (e.g. contractor type companies). A company qualifies if it doesn’t exceed two or more of the following criteria:
- Turnover: £1,000,000
- Balance Sheet total: £500,000
- Number of employees: 10
Determining if the company is using historic cost or fair value accounting
Accounts must be drawn up using generally accepted accounting practice (GAAP). Within that framework, you will encounter two regimes depending on the size of the company you’re advising. Ask to see the accounts.
If it’s a particularly small micro entity then the accounts will be prepared using Financial Reporting Standard 105. A contractor company is likely to be a micro entity. These companies enjoy simplified accounting rules. There’s little point essentially in applying complex accounting rules to very small companies.
If the company doesn’t qualify as a micro entity, as it’s bigger in size, then the accounts will be prepared using Financial Reporting Standard 102. This ensures the accounts are a bit more advanced than a micro which makes sense I think.
If there is any uncertainty the accountant will be able to clarify the regime for you.
Final thoughts
The text above serves as a useful reminder that companies come in all shapes and sizes and so a potential investment could be millions of pounds or could equally be just £20,000 or so. Regardless of size, remember that not all companies have investible funds and for those that do, the focus is typically on those companies able to tie funds up for a minimum of five years.
Main image: kelly-sikkema-XDLoljHoRZY-unsplash
