With interest rates and inflation at their lowest levels for years and
indications that they will remain or even fall over the next few years,
investors are searching for alternatives to traditional deposit accounts.
But it is not just personal wealth that is under pressure. Companies with
cash reserves – known as corporate money – are struggling with the same
DTI data indicates that, for the fifth successive year, the number of UK
enterprises remained fairly stable at 3.7 million in 1999. The vast
majority (99 per cent) are small companies with fewer than 50 employees.
These are generally owner-managed businesses which would look towards IFAs
and professional connections for financial advice.
Around half have working capital of more than £100,000 but nearly one
in eight have working capital exceeding £1m. These figures support
anecdotal evidence that many small family companies have generated cash
reserves, leaving earned profits within the company structure.
How does this working capital get used? A proportion, possibly quite
large, will become tied up with the ongoing capital needs of the business
operations including salaries, fuel and equipment. However, many small to
medium-sized businesses are so busy running these operations that, if any
of the capital is unused, it gets forgotten.
Typically, they may consider the entire capital asset as one entity held
as a lump sum in a deposit account. However it could be seen in two parts –
operational capital for the running of business operations and investment
Business accounts generally attract a lower rate of interest than personal
accounts. Therefore, businesses should be looking to remove unused capital
from this sort of account. What is the alternative?
Corporate money should be considered as part of an overall financial plan.
Banks and building society accounts offer easy access, capital security,
familiarity and banking support services. But for the medium to longer term
there is a downside in that the rate of return is historically poor.
Deposit account interest is taxed on an arising basis, leaving no scope for
tax planning, and once the interest is withdrawn the cash is stagnant with
no capital growth.
The three main alternatives for cash reserves are pension funding, then a
balance set aside as working capital, leaving surplus funds available for
Company reserves and pension schemes are not in competition. If funding a
company pension scheme is right for the business and/or employees, this can
be a highly tax-efficient route to follow and should be the first priority.
But the company scheme may have already reached the maximum funding limits
or the directors may feel they want to hold back money for the future needs
of the business.
How can businesses get the most out of their investment capital? The
directors are likely to place importance on certain criteria such as the
potential of a good rate of return in excess of inflation, capital security
against short-term market fluctuations and tax control. The table (below)
compares these criteria as they apply to different types of investment.
An offshore investment bond offers the potential to provide a solution for
all corporate situations. The investment grows in a virtually tax-free
environment and, even if the company is earning high profits, there will be
no tax charge until a chargeable event occurs. An investment bond is a
non-income-producing asset which means there will be a reduction in
corporation tax in relation to interest previously taxed on an arising
Offshore investment bonds provide diverse tax-efficient investment
opportunities within one tax and administrative wrapper. This carries less
onerous reporting requirements. These bonds also have the advantage of
being able to accept collective investments and offer a wide range of
actively managed funds covering the entire risk spectrum, including
offshore with-profits, with the benefit of no tax consequences on switching
between funds or fund managers.
Clearly, there is an opportunity here for IFAs. With the Bank of England
base rate at 5.25 per cent and indications of further reductions to come,
IFAs have the potential to create true added value for clients if they can
secure an income return of perhaps twice this rate using flexible bond
alternatives. The declining interest rate environment provides an
opportunity for IFAs to review their corporate clients to make unused – or
investment – capital work harder.