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Taper tiger

In the coming weeks, I will look in some detail at the significant negative impact on business assets taper relief that an investment by a private company can have. Of course, business assets taper relief is not available to the company and so does not affect the taxation of the investment itself. It can, however, be relevant for a shareholder in the investing company if that shareholder disposes of his or her shares and makes a capital gain.

With business assets taper relief (expected to be available in full after only two years of ownership in respect of disposals made after April 5, 2002), gains can be reduced by up to 75 per cent. This means the effective rate of tax on the gain will be 10 per cent (40 per cent on 25 per cent of the gain) for higher-rate taxpayers. Without business assets taper relief, the less favourable non-business assets taper relief will apply which, after two years ownership, would offer no relief at all.

Of course, there would be any unused annual exemption but that would be available even if the disposal did qualify for business assets taper relief.

As I have said before, it is not a relief to be messed around with. Substantial investment can cause the company to cease to be a trading company or cause it to “commence the business of holding investments”. As Harry Enfield would say, you don&#39t want to do that.

To satisfy the trading company test, the company must exist wholly for the purpose of carrying on one or more trades or fall within that definition apart from any purposes capable of having no substantial effect on the company&#39s activities. The Inland Revenue adopts a 20 per cent test here.

Twenty per cent of what (turnover from non-trading activities, assets, expenses) will depend on the facts of each case, so there is not as much clarity as we would like here. Where a company invests in, say, a single-premium bond (a non-income producing asset), it is unlikely that the turnover test would be applied. But an assets test may not look good if it is, say, a knowledge-based company with little on the balance sheet. Would the value of goodwill or any brand be taken into account? If intangibles are not considered, then breaching the 20 per cent test based on assets may be a possibility.

Subject to the taper relief risk, what are the tax implications for the corporate investment? Before considering tax, it is important to remember the tax tail should not be allowed to wag the investment dog. By the way, what is an investment dog? A Crufts winner? A poorly performing fund? But I digress.

It is important to remember that, with any available funds, a company has an investment decision to make. Choices include leaving the funds on deposit, investing in staff, making payments to owners, paying into pensions, investing in capital equipment or property, to name a few. But the choices also include investments made available by the retail financial services industry, namely Oeics, unit trusts, investment trusts, portfolio management products and insurance products.

Whichever is chosen, funds invested will not leave the company or will be held for the benefit of the directors/shareholders. The fact that shareholders benefit indirectly by value of their shareholding does not affect this. This means that (apart from the taper relief issue) there will be no direct tax implications for the directors/shareholders as a result of the investment being made. Let us look first at collective investments – investment trusts, Oeics and unit trusts.

It is worth reminding you that companies cannot invest in an Isa. They can, of course, pay amounts to shareholding directors or employees and the net sums received can be invested in an Isa. But that is not what we are considering here.

Before looking at the issue of tax, it is important that the company matches the qualities of the investment with expectations regarding risk, access, charges and likely timeframe. Appropriateness is just as important for companies as for individuals. Assuming this to be acceptable, it will next be important to ascertain the taxation of any income produced by the investment. Dividends received from collectives bear no further tax so good news there. Interest will be subject to corporation tax in the usual way.

Turning to capital gains, companies do not qualify for any form of taper relief. Indexation relief is, however, available. There is also no annual exemption and, as for individuals, tax on gains (corporation tax not capital gains tax for corporate investors) is not an issue until any gain is realised. Tax will be paid as part of the corporation tax bill. For most companies, this will be nine months after the end of the accounting period when the gain is made.

The system of tax is then relatively uncomplicated. For wrapper or nominee portfolio management services, dividends bear no further tax and gains made on disposal by the nominee will be taxed as having been made by the corporate investor. The big difference is that gains arising on the disposal of the investments underlying an Oeic, unit trust or investment trust will not be subject to tax as they will not be treated as those of the investor. The trade-off is that the investor will not, in most cases, have control over what the fund manager invests in and when disposals are made.

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