Insights for Business Owners November 2017
Investing Corporate Cash: Structuring Company Investments in a Tax Efficient Manner
Director - Financial Planning
We are living in a period of historically low interest rates and, as a result, cash deposits have become an ineffective way of preserving the purchasing power of capital. There is now a significant risk that inflation will erode the real value of assets held in cash over an extended period.
For business owners formulating a strategy to manage the appropriate level of corporate cash, the first step to is to decide whether an investment policy should be adopted. Some key considerations of this process are:
- Establish the level of working capital required for the business including funds required for short-term capital projects;
- For excess capital that is not required for the business, what are the longer term objectives?
- Assuming it is to be invested in non-trading assets, what are the options?
- What are the structures I need to consider; and
- What are the tax implications of the different strategies
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This article is taken from the latest issue of Insights for Business Owners, a twice-yearly email publication which provides business owners with expert analysis of the latest economic & investment topics affecting corporates, as well as special features and profiles of leading business owners.
Structures to be considered
This is a complex area as it involves dealing with the requirements of the company and the personal objectives of the shareholders. Each case should be dealt with based on the particular facts and objectives of the business and the shareholders. However some options that you could consider are:
1. Pension funding
Rather than investing the funds in the company, consider funding your pension and investing through this structure. Some of the advantages and disadvantages of this approach include:
- Tax-free growth with an ability to extract 25% as a lump sum upon retirement;
- Tax deduction for trading companies for employer contributions;
- Assists with succession planning as it allows for:
- a separate pool of capital to provide for an income in retirement independent of the company; and
- an additional asset that can be left to children who do not inherit the family business;
- Assists with creditor protection as it is typically segregated from the business; and
- Helps to ensure that the business is regarded as a trading business for the purposes of the reliefs that can, subject to certain conditions, allow the business to pass the next generation tax efficiently.
- The capital is effectively ring-fenced and not available for company or personal use until retirement; and
- A 40% exit tax applies on any chargeable excess over the Standard Fund Threshold of €2 million.
A pension should form a part of any business owner’s financial lifetime plan as it gives many options to the shareholder when he/she has to deal with the succession of the business and the equalisation of the estate, while it also provides for an independent source of income in retirement.
2. Investing in the company
Where the funds are invested through the trading entity, then accessing the markets can be done in two ways:
a) through a gross roll up structure; or
b) through direct holdings.
It should be noted that investing through a corporate structure exposes the shareholder to a double tax charge: the first on the sale by the company and the second on the extraction of the net funds by the shareholder.
a) Gross roll up structures (funds/indices)
A gross roll up structure allows the company to invest for an eight-year period before incurring a tax charge where a payment on account equal to 25% of the growth in the fund will arise. On the ultimate sale of the investment (be that partial or otherwise), credit is available for the eight-year charge against the ultimate liability.
- Funds can provide more liquidity depending on their size;
- Helps diversify the risk from an investment perspective;
- Gross roll up every eight years (surcharge only applies once ultimate disposal occurs);and
- Tax is 25% versus 33% Capital Gains Tax (CGT) (ignoring surcharge).
- In general a surcharge of 20% could apply to undistributed income. This would bring the rate from 25% to 40%; and
- Losses can be restricted for investments held directly in individual funds as opposed to an overall fund structure.
b) Direct holdings
At a basic level these types of investments are stocks and shares, bonds, property and cash, which pay CGT on gains at 33% and 25% corporation tax on dividends and interest versus the 25% fund exit tax and potential surcharge of 15% (20% of the net funds of 75% = 15%).
- Exposure to concentration risk by investing in single stocks;
- Unlike fund investing, losses incurred on the sale of individually held stocks are not restricted; and
- Gross roll up on gains if it is a long-term hold.
- Investment risk can be higher; and
- A surcharge of 15% could apply to undistributed income.
A summary of the tax rates for corporates is outlined in Figure 1.
Figure 1: Summary of corporate tax rates (as at October 2017)
Some other points to consider
Some of the other considerations to be taken into account when company owners invest surplus cash include:
- Should you reorganise the company into a trading entity and an investment entity?;
- The impact the investment will have on the shareholders’ eligibility for various reliefs, e.g. Business Asset Relief and Retirement Relief (which allow the business to pass to the next generation largely free from tax);
- Will the surplus cash affect my ability of claiming entrepreneur’s relief (€1 million at 10%)?;
- Surplus cash can help with equalising your estate by providing an additional asset separate from the company for children who do not work in the business; and
- Your Will should reflect who you want to inherit the business.
There are a number of tax and structuring issues that business owners need to take into account when investing surplus corporate cash. Each case is different and the approach taken should be looked at as part of a tailored personal financial and succession plan.
If you would like to discuss these options and the best route for your business to invest surplus cash, please contact a Davy adviser.
Warning: The information contained in this article is based on Davy’s understanding of current tax legislation in Ireland and is subject to change without notice. It is intended as a guide only and not as a substitute for professional advice. Please note that Davy does not provide tax or legal advice, nor accept liability for it. You should consult your tax adviser for the rules that apply in your individual circumstances.
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