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Put company cash to work

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

problem.

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

capital.

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tax planning, and once the interest is withdrawn the cash is stagnant with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

investment.

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

basis.

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.

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