One key reason directors are looking at investing money in their businesses is low interest rates.
Directors could be increasingly concerned at the poor returns available on deposit accounts. However, despite this, they will have the comfort of knowing the funds will be available when they may be required.
In addition to the above There are some other reasons to consider whether investing into the investment markets via an investment bond could work for a company investment:
- ‘Basic rate credit’ mechanism – tax rules give recognition to the fact that UK bonds will have suffered life fund taxation.
- Although tax is treated as having been paid at 20% basic rate, the effective tax rate applying to the fund is always less than 20%.
- Dividends are exempt from tax; gains are taxed at 20%, and where certain capital gains are made on or after 1 January 2018, then indexation allowance will be applied, calculated up to December 2017.
- No ‘surrender penalties’ – although a bond is seen as a medium to long term investment, directors can access it without any penalty or having to leave it invested for a fixed term – they can get their money when they need it.
- Although the bond itself will not suffer any surrender penalties, it’s important to remember that some funds might.
The combination of these factors means that an investment bond, with an appropriate underlying fund choice, could be a more attractive investment opportunity for a company’s surplus cash rather than it is sitting on deposit.
What about tax?
This is an important area to understand. How a company is taxed depends on what ‘size’ of company it is. Micro-entities can use historic cost accounting for insurance bonds. Larger companies use fair value rules.
The following hypothetical examples show the difference the two accounting methods have on how the bond is taxed. In both scenarios the following takes place:
- Company (accounting year-end 31 March) invests £200,000 in September 2018
- On 31 March 2019, the value of the bond is £210,000
- On 31 March 2020, the value of the bond increased to £230,000
- In April 2020 the company cashes in the bond for £230,000
Historic cost accounting
- Period to 31 March 2019 – historic cost £200,000: no tax consequences
- Period to 31 March 2020 – historic cost £200,000: no tax consequences
- Period to 31 March 2021 – cashed in for £230,000: Gain: £30,000 which is grossed up (as underlying fund has effectively been taxed at 20% whilst in the bond): £30,000 x 100/80 = £37,500 and this profit is at 19% = £7,125.
- As the tax has already been paid in the bond, a ‘basic rate credit’ is applied which is offset against the Corporation Tax liability in this year – so no tax to pay
Fair value accounting
- Period to 31 March 2019 – bond valued at £210,000: Increase of £10,000 x 19% (Corporation Tax) – £1,900 tax due
- Period to 31 March 2020 – bond valued at £230,000: Increase of £20,000 x 19% 31 (Corporation Tax) = £3,800
- Period to 31 March 2021 – cashed in for £230,000: Profit = £30,000 (£10,000 + £20,000) which is grossed up (as underlying fund has effectively been taxed at 20% whilst in the bond): £30,000 x 100/80 = £37,500
- From that grossed up gain, we can deduct £10,000 and £20,000 as those amounts have already been taxed in the periods ended 31 March 2019 & 2020. That leaves a figure of just £7,500 which taxed at 19% = £1,425
- The £1,425 Corporation Tax due in the period ended 31 March 2021 is covered by the £7,500 ‘basic rate credit’.
- The remaining £6,075 is available to offset against any other tax liability in the accounting period.
A company will be considered a Micro-entity if it has any two of the following:
- A turnover of less than £632,000
- £316,000 or less on the Balance Sheet
- 10 employees or less.
Impact on tax reliefs
There are two tax reliefs we will look at in relation a company investing in a bond. These are:
- Inheritance tax Business Property Relief (BPR)
- Capital Gains Tax (CGT) Business Asset Disposal Relief
Inheritance tax BPR
If a shareholder in a company dies, then three conditions need to be satisfied to obtain 100% relief:
- The ownership test: Must have owned business for at least two years before death
- Bond has no impact on this
- The investment test: No relief where the business consists wholly or mainly (i.e., 50% or more) of investment activities
- Bond should have no impact on this as long as it is not too big relative to the size of the company
- The excepted asset test: Excepted assets must be excluded for BPR purposes
- Surplus funds held for no identifiable business purpose are likely to be treated as an ‘excepted asset’ whether in cash or whether invested so a bond (or vice versa) should have no impact.
CGT Business Asset Disposal Relief For lifetime gains up to £1m,
Business Asset Disposal Relief delivers a CGT rate of 10%. It is a very valuable relief. The company must be ‘mainly’ trading in the 24 months prior to sale. HMRC apply a 20% benchmark and therefore any investment activities must be kept within this to qualify for relief.
There is no single indicator when considering this 20% test. Instead, the test should be applied ‘in the round’ – this means that there could be other indicators to consider when establishing if it’s a non-trading activity. You can find out more details on the HMRC website: www.gov.uk/hmrcinternal-manuals/capital-gains-manual/cg64090
In the case of surplus cash or an investment of those funds, it would seem logical to primarily focus on the asset base of the company when considering the 20% test. If a sale of the business is planned, then the accountant will monitor the position to ensure the 20% test is not breached in the 24 months prior to the sale. This might simply involve spending or extracting some of those surplus funds.
If you want to talk about anything, feel free to book a free no-obligation chat here.
It is important to remember the value of any investment can go down as well as up and you might get back less than you have put in.