Over recent years, more and more business owners are seeking to diversify their excess cash, or plan ahead for the increasingly harsh inheritance tax (IHT) landscape, through structures such as Family Investment Companies. This often sees a corporate entity make investments either directly into stocks and shares, or through portfolio providers and financial advisers.
The reporting provided by portfolio providers is often set up for personal tax requirements, rather than corporate tax, which can result in unknown tax charges and ‘dry’ tax charges when previously advised as being tax efficient.
This article summarises the potential pitfalls and differences that can arise.
‘Dry’ tax charges
Where a company holds investments in debt-based assets, such as gilts or certain bonds and funds, the tax treatment can differ to that of traditional share investments. Such investments can fall within the loan relationship rules and be taxed broadly the same way as interest income. Particular care is required when investing through collective investment funds as, if more than 60% of the underlying investments held by a bond are interest-based investments, this would result in that bond or fund being taxed under the loan relationship rules. If the investment is 60% or less then they are generally taxed as an equity-based investment.
The below table summarises how each type of investment is taxed:
| Equity investments | Loan relationship Investments | |
| Taxation of income | Income is usually exempt. Certain overseas countries are taxable (Bermuda, Cayman Islands etc) | Taxed as a loan relationship credit on an accruals basis |
| Taxation on sale | Taxable gain or loss based on original base cost versus proceeds received | Taxed as a loan relationship credit or debit on the proceeds on disposal less market value at the beginning of the period or date of purchase (whichever is later) |
| Taxation on Revaluation | No tax on revaluation | Taxable loan relationship credit or debit on each revaluation based on the movement in the accounting period. |
Therefore, some bonds may not be structured in a tax efficient way, creating taxable profits without the company having the means to be able to pay the resulting tax due to the cash being tied up within the bond itself.
Personal tax and corporate tax on investments: the differences
Most financial advisers and portfolio providers prepare a tax report at the end of the tax year for their clients. The issue we face as advisers is that these reports are often not prepared from the perspective of a corporate entity and therefore present several problems where the actual tax treatment differs to that contained within the report. Below are some examples of such differences:
- Gilts: from a personal tax perspective gilts are well known to be exempt, however, for a company they are not and fall under the loan relationship rules. Potentially, this may create the dry tax charges mentioned above.
- Share disposals: the reporting for capital gains differs between personal and corporate investors. The reports could potentially miss items such as indexation relief or may have the wrong base cost entirely. This is due to the difference in the bed and breakfast rules for share pooling between personal and corporate tax.
- Bonds: the above dry tax charges are not identified in the tax reports and often do not include sufficient detail to tax these correctly. Significant work is required to identify each investment to ensure the disclosure is right.
- Dates: the reports are often generated on a tax year basis, while companies will not often have the same year end. This can create mismatches and make it difficult to obtain the correct information for the corporation tax return.
Company accounts
Depending on the nature and size of your company, the accounts you are required to produce can change. For smaller entities they may be able to adopt FRS105 accounts. The key advantage of this is that investments can be held at cost, resulting in no fair value movements or dry tax charges on the investments held under loan relationship rules.
However, pure investment companies cannot adopt such accounts. You therefore need to consider this carefully when preparing the company’s accounts.
How we can help
At Hazlewoods, we have built up a specialism in the taxation of investments, working alongside our clients and IFAs to structure company investments to avoid dry tax charges and ensure correct reporting.
If you are thinking of making investments or setting up a family investment company, we can help from implementation and investment all the way through to the annual reporting requirements.
