Ten Common tax questions answered regarding companies investing in Onshore and Offshore Insurance Bonds and OEICs.
How are these investments 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.
How is an Insurance Bond investment taxed inside the company?
The chargeable event rules applicable to individuals, trustees and personal representatives don’t apply to companies (so, no 5% rule!). Instead, the ‘loan relationship’ rules apply which have a much wider remit than just investment bonds. Although complex, in broad terms, the rules require the taxation treatment of the item in question (i.e. the Bond) to follow the accounting treatment. There are different accounting standards that a company might use but typically, ‘micro entities’ will use historic cost accounting with larger companies using fair value rules.
Qualifying rules for a micro entity
A company qualifies as a micro entity if it doesn’t exceed two or more of the following criteria:
- Turnover: £632,000
- Balance Sheet total: £316,000
- Number of employees: 10
The accounting method should be clear from the accounts, and the accountant will, of course, confirm.
How does a micro entity account for an Insurance Bond?
Micro entities are very common. Think of an IT or medical contractor for example.
With a micro entity being small in size, it can enjoy ‘simple’ accounting methods by applying Financial Reporting Standard (FRS) 105. In particular, the Bond will not be measured at fair value (see below) and instead historic cost will apply.
Historic Cost example
The bond is simply shown in the balance sheet at the end of the accounting period at original premium amount, regardless of the actual surrender value. No annual gain (or loss) is recognised in the accounts, meaning no corporation tax consequences arise because the tax treatment follows the accounting treatment. The company achieves tax deferral until there is a disposal event such as full surrender, part surrender or death of last life assured.
How does a larger, non-micro company account for an Insurance Bond?
The majority of large and medium-sized UK entities apply FRS 102 when preparing accounts. Under FRS102, "basic financial instruments" can be valued at historic cost but a typical Insurance Bond won’t meet that definition. Therefore, Insurance Bonds are typically accounted for under the fair value regime.
Fair Value example
The Balance Sheet at the end of the accounting period includes the bond at its surrender value. Accordingly, the movement in value (gain or loss) has been processed through the Profit and Loss Account. That movement has tax consequences. There is no tax deferral since the increase in value is subject to corporation tax (any decrease is potentially relievable).
If a company invests Onshore, does the Onshore Bond ‘tax credit’ apply?
The company is treated as having paid 20% tax on the gain arising on a disposal event. In practice the effective rate of tax within the fund will be lower - bear in mind that dividends received within the fund are tax exempt. The 20% deemed paid can be set against the company’s corporation tax liability for the accounting period in question.
This does not apply to annual gains arising on Onshore Bonds for companies using fair value accounting. However, the above rule does reflect the earlier gain by allowing subsequent relief when there is a disposal event.
Where the 20% tax credit on a disposal event exceeds the company’s tax liability, the excess is not repayable or offsetable in any other accounting period.
Is there a simple comparison of a micro entity investing Onshore versus an Offshore Bond?
For a micro entity using Historic Cost accounting, no annual gain (or loss) is recognised in the accounts, meaning no tax consequences arise regardless of Onshore or Offshore. 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, currently at 19%, but the 20% tax credit exceeds that. Effectively therefore no corporation tax is due. 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 19% (currently) corporation tax on the gain.
Both Onshore and Offshore Bonds have their own merits for micro entities.
From 1 April 2023, the corporation tax main rate will be increased to 25% for profits over £250,000. A small profits rate will also be introduced for companies with profits of £50,000 or less so that they will continue to pay corporation tax at 19%. Companies with profits between £50,000 and £250,000 will pay tax at the main rate reduced by a marginal relief providing a gradual increase in the effective corporation tax rate. These forthcoming corporation tax changes are explored here.
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 only applies on a subsequent disposal event. Effectively therefore, double taxation occurs on those annual increases i.e. life fund tax and corporation tax paid by the company on that net return. The benefit of the ‘tax credit’ on disposal rectifies that, but the credit can only be offset against the company's overall tax liability for the accounting period in question. If the credit exceeds the tax liability, the excess is not repayable and neither can it be set off against any prior or future accounting periods. Therefore for a company encashing the bond in an accounting period in which there is no corporation tax liability, then the benefit of that tax credit would be lost.
For directors of ‘fair value’ companies with fluctuating profits, concerned about potentially wasting a tax credit in the accounting period of disposal, then an Offshore Bond is the solution. The company pays tax annually on a gross return (i.e. gross roll-up within the fund) with no tax credit to consider.
How are company owned OEICs taxed?
In contrast to a non-income producing Bond, an OEIC must distribute income.
If the fund is more than 60% invested in interest paying assets then it will pay interest. If not, it will pay tax exempt dividends. Does this present an opportunity for a corporate investor - invest in a fund which falls short of the 60% rule so that it pays dividends thereby turning taxable interest into tax free dividends?
No. Where a company invests in an OEIC fund paying dividends then the rule is that the provider ‘streams’ the distribution so that the company will be informed that X% is tax free dividend & Y% is taxable interest.
What about capital growth?
Example of micro entity using historic cost accounting
Regardless of the fund type the gain will simply be subject to corporation tax on disposal.
Example of a larger company using fair value accounting
A fund passing the 60% ‘test’ falls under those same loan relationship rules as Bonds so will be revalued and taxed annually. Equity funds don’t so although the accounts might reflect the growth, the tax wouldn’t follow suit but would only arise on disposal.
Could an investment of surplus cash impact on the availability of IHT Business Relief?
For shareholders in private companies which are not wholly or mainly carrying on investment activities, then Business Relief, or Business Property Relief (BPR) can give 100% relief from IHT. Tax rules prevent shareholders getting relief for non-business assets and so, the value of ‘excepted assets’ is ignored when calculating BPR. Excess surplus cash can be an excepted asset if it is 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 BPR.
- Excess cash is as much an ‘excepted asset’ as an investment – so switching from cash to investment (or vice versa) shouldn’t impact BPR.
- 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.
Could an investment of surplus cash impact on the availability of 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 will 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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