Corporate funds

Many small to medium sized enterprises (SME’s) trade carrying an overdraft and have little surplus cash. There are a number, however, which do have some fairly substantial sums on deposit – this can be particularly so for small companies who are liable to tax on their profits at a rate of Corporation Tax of only 19%.

The temptation for the company is to retain certain amounts of profit within the company rather than distributing them as dividend income or paying them away as salary. This is because the 19% Corporation Tax rate is considerably lower than the individual recipient’s income tax rate if any of the extracted profit would fall to be taxed at the higher rate of income tax. The additional burden of class 1 National Insurance Contributions must also be considered if the profits are extracted as salary.

The problems

For companies in this position, this can lead to two distinctly uncomfortable dilemmas:

• The returns enjoyed and the Corporation Tax position on that return

Whether the asset can affect the availability (or not!) of business asset taper relief on, for example, the ultimate sale of shares in the company – i.e. “Exit” planning.

In addition to this any interest credited gross to companies, will also be subject to Corporation Tax in the accounting period of “receipt”. For a company where this would trigger a 19% Corporation Tax liability the return would effectively be reduced, fairly obviously, to 81% of the gross amount credited.

Solutions

A first step is to investigate whether the company can make any contributions to pension arrangements on behalf of the shareholding directors. This should attract tax reliefs for the company and can be a very tax efficient way of actually extracting the cash from the company. 

If this is not possible and the company sees the surplus cash as a fairly long term situation, i.e. it does not foresee the need to utilise the funds for business use as distribution for, say, at least the next five years there are alternative investment strategies that can give
an advantageous tax position and should lead to increased fund returns to the company even if the actual “investment” performance is not improved.

How can this be achieved?

There are two forms of “collective” investment that may achieve the desired result. The first is an “offshore” single premium life assurance bond investment which can be written in a special way to facilitate long-term deferral of any tax liability on return whilst at the same time giving access to part of the capital invested, also without “triggering” a Corporation Tax liability at that time.

The second is by investing in UK mutual funds ie unit trusts (including “Fund of Fund” unit trusts) open-ended investment companies (OEICs) and investment trusts. These should be of the nil or extremely low yielding variety as far as income is concerned.

Each of these forms of investment have different tax and investment features which should appeal in different ways to small private limited trading companies, depending on their own individual circumstances.

As an example, under the offshore “single premium bond” route it is possible to defer Corporation Tax on any income or gains arising to the contract whilst at the same time being able to enjoy certain capital payments back to the company, also without having to pay tax at that time. This is a major tax deferral/planning opportunity.

On the other side of the coin, use of UK mutual funds as outlined can also , in the right circumstances, give major taxation advantages, not the least being that a company investing in these vehicles can still enjoy indexation relief on eventual gain as and when it is realised.

In both instances, it is possible to have flexible fund management to switch between funds also with no Corporation Tax liability on the company at the time of the switch. If this facility is to be enjoyed as far as UK mutual fund investment is concerned then this has to be via a “Fund of Funds” or "Manager of Manager" unit trust.

Action

It is in a company's interests if it is in a “surplus cash” situation as outlined to at least investigate the possibility of diversifying some of their long-term monies into areas where any returns can be enjoyed in a more tax efficient manner – it can even be possible to arrange this through one of the avenues explained and retain a cash-based fund approach if this is desired.

This is an area where Jelf Financial Planning Ltd specialises and we would be delighted to assist you with your relevant clients.

Brian Lawless LLB (Hons) FCII Dip PFS FRSA TEP
Business Development Director
Jelf Private Clients

The Jelf Group, Jelf Corporate Consultancy, Jelf Private Clients, Bath Financial Planning, Jelf Mortgage Solutions and A Wills & Co are trading names of Jelf Financial Planning Ltd.  Goss & Co (Financial Services) Ltd (Reg No. 01056091) and Jelf Financial Planning Ltd (Reg No. 3072281), part of Jelf Group plc are authorised and regulated by the Financial Services Authority (FSA).  Registered address: Fromeforde House, Church Road, Yate, Bristol, BS37 5JB - Tel: 01454 272727 - Fax: 01454 272728.  Not all products and services offered are regulated by the FSA.

This document was reviewed and updated 13th July 2006