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A case in point

The headlines relating to this year’s Budget were understandably grabbed by the 50 per cent tax rate (from November 2010) and the removal, from April 6, 2011, of higher-rate tax relief on pension contributions for those with taxable income of £150,000 or more. But there were also some important changes for businesses – the three-year trading loss carryback rules and the holding of the small companies’ rate at 21 per cent, for example.

And there were three other important provisions. The continuation of the annual investment allowance (effectively 100 per cent relief on qualifying expenditure of up to £50,000 by a business), the introduction of the 40 per cent first-year allowance for most expenditure on capital equipment in excess of £50,000 and the continuing availability of tax deduct-ibility for employer-paid pensions contribution could all create a very tax-attractive proposition for some incorporated businesses (that is, companies).

How? Well, especially in the current challenging economic environment, there may be some companies which would like, but cannot afford, to both re-equip the company tax-efficiently and provide for the retirement of owner/managers through pension contributions. In these cases, there may be an opportunity to have the best of both worlds.

Say a company expects to make a profit of £100,000, has £50,000 available and an existing SSAS fund of £250,000. It wants to purchase capital equipment to take advantage of a commercial opportunity to improve revenue, profit and market share and is particularly keen to do so given that the whole £50,000 expended would be deductible for corporation tax purposes.

The company makes a pension contribution of £50,000. This increases the pension fund value to £300,000. The payment is for the three full-time working shareholding directors and is allowed as a deduction being incurred (based on the facts) wholly and exclusively for the purposes of the company’s trade. Even though it is not a normal regular contribution, none of the directors has taxable income that exceeds £150,000 and, in any event, the total payments to the scheme for each of them is less than £20,000. The payment does not, therefore, give rise to any special annual allowance charge for any of the directors.

A loan from the pension fund to the company of £50,000 is arranged. This is less than 50 per cent of the value of the fund. The loan is secured on company property worth more than £50,000. A five-year repayment schedule (comprising capital and interest) is agreed and interest is set at the appropriate level.

The company spends the £50,000 borrowed on the capital equipment. Even though it has only spent £50,000 on the pension (with £50,000 then being “recycled” by loan), its taxable profits would be reduced by £100,000. The company would thus have had £21,000 of tax relief on £50,000 of real expenditure. It would, however, have accepted the need to make loan repayments but the interest part of each repayment would, usually, be tax-deductible.

This position is illustrated as follows:

Taxable profits £100,000SSAS contribution (£50,000)

Purchase of plant/ machinery (£50,000)

Net profit NilLoanback from SSAS £50,000Cash available £50,000

In the example, the business had profits of £100,000. By paying a pension contribution of £50,000 and by the purchase of plant/machinery for £50,000, the profits are reduced to zero, resulting in a corporation tax saving of £21,000.

The company’s cashflow has, however, been increased by £50,000 as a loan of £50,000 has been made from the company’s SSAS. Such a loan was an authorised employer loan as it represented no more than 50 per cent of the value of the SSAS’s assets.

Therefore, on a total expenditure of £100,000, the company is left with £50,000 working capital and has benefited from £21,000 corporation tax relief. This represents an effective rate of tax relief of 42 per cent on its net outlay of £50,000.

This makes for an interesting case study but, in practice, before such a course of action is adopted it would be necessary to be satisfied that the whole arrangement is commercially justifiable and that cashflow implications over the term of the loan are fully understood. Tax should definitely not be allowed to be the driving factor but the strategy may at least be worth discussing with targeted corporate clients.

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