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Event horizon

Last week, I looked at the Inland Revenue onslaught on the use of capital redemption bonds which sees corporate-held CRBs taken outside the chargeable-event rules. What will this move mean in practice?

First, it is important to note that the loan relationship rules generally only apply to UK companies so policyholders who are non-UK companies, individuals or trustees are unaffected. CRBs owned by such persons remain within the chargeable-event legislation.

Under the loan relationship rules, in basic terms, corporation tax is levied,on an annual basis, on profits, gains and losses arising on a company’s loan relationships (broadly, all money debt both UK and foreign) during that year.

The exact nature of the charge on profit from the CRB will depend on how the CRB is accounted for – either a mark-to-market(fair value) or amortised cost basis.

In the context of the holding of a CRB, this means that the company will be taxed on a year-on-year basis, irrespective of whether the policy is encashed.

From this, it follows that tax on gains and profits within the CRB funds cannot be deferred until the happening of a chargeable event as it could before February 10, 2005.

Profits and losses accrued after February 9, 2005 will fall outside of the chargeable events’ legislation because they are otherwise chargeable to tax, that is, under the loan relationship rules.

For a CRB in force on February 9, it will be treated as having been assigned for consideration on that date at its then value but any chargeable-event gain that arises on this deemed assignment will be deferred until the policy matures or is actually assigned or surrendered.

The fact that CRBs are now within the loan relationship rules does not mean the end of tax deferral for company investments such as single-premium life insurance bonds.

However, if an insurance product is to be effected it will be essential, so as to maximise flexibility and avoid an unwanted “early” encashment, to have the bond effected on a multiple lives’ assured last-survivor basis.

The lives to be assured would typically be the directors of the company and medical underwriting would not usually be required.

It will also be important from a tax standpoint that the insurance product is an offshore bond. This is because a corporate investor will receive no tax credit for tax suffered at fund level under a UK bond. This can, it will be appreciated, significantly add to the tax cost on any realised gains.

For example, even if a UK life fund suffered tax at an overall effective rate of, say, 15 per cent (taking account of nil tax on dividends, only after-indexed gains being assessed and deductible expenses) and the corporate rate were 19 per cent the overall tax rate on bond gains would be 31.15 per cent, in effect turning the small companies’ rate into more than the main rate of corporation tax.

For any investment by an unquoted company, regardless of the investment wrapper chosen, it is important that the owners take into account the potentially disastrous effect that such an investment can have on the availability of CGT business assets taper relief.

Given that this could reduce the effective rate of tax on a gain made on the sale of shares in the company from 40 per cent to 10 per cent this is not a subject to be taken lightly.

I will look at this in more detail next week.

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