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The Biggs issue

Last week, I continued my look at corporate investment in the light of the extension of the loan relationship rules to all investment life policies.

At the time of writing last week’s article, we had just received notification of the introduction of entrepreneurs’ relief for capital gains tax. Unfortunately, we still do not have the draft legislation.

However, it seems clear that to qualify for entrepreneurs’ relief, the company will have to be trading and the shareholder must have a material interest in the company of at least 5 per cent of the voting shares and be an officer or employee of the company.

Importantly, the company will need to be trading and the definition is likely to be taken from the taper relief provisions. This would seem to mean that the substantially trading test – and thus the much loved 20 per cent test – will be relevant.

This is of importance when you come to consider the appropriateness of corporate investment. If the taper relief test is incorporated into the entrepreneurs’ relief legislation, a substantial investment could be relevant and would be detrimental to securing entrepreneurs’ relief. You will recall that the 20 per cent test could be applied to assets, activities or profit, as HM Revenue & Customs saw fit.

Many practitioners are vocal in suggesting that a more holistic test should be applied. Suffice to say that when a company moves even retained profit-generated funds off deposit and makes a positive decision to invest, the risk to entrepreneurs’ relief could be considerable.

The good news is that the entrepreneurs’ relief conditions have to be satisfied for only a year, so if there is a perceived risk, it would seems that disinvestment for a full year ahead of a claim for this relief would seem to be a workable strategy. Let us wait and see the draft legislation before going any further. All the foregoing is subject to this caveat.

I will return to entrepreneurs’ relief in a later article. Now I would like to look at some examples of how the loan relationship rules would seem to work in connection with investment bonds effected by UK-resident companies.

In Example 1, Biggs & Co is a UK company which pays corporation tax at 28 per cent (the main rate for the financial year beginning April 1, 2008) and is invested in a single-premium bond issued by a UK-resident life company. If the investment were in an offshore bond, the calculation process would follow similar lines except there would be no fund tax. The profit, all other things being equal, would be greater. There would be no fund tax offset, so there would be no reduction of the loan relationship charge borne by the investing company. Thus, the investing company would pay more year on year but the value of the bond, undiminished by fund tax would be greater.

How about if the bond goes down in value? In Example 2, Biggs & Co has an accounting year which begins on June 30, 2008. On July 1, 2008, it buys a single-premium bond for £100,000 which has decreased in value to £95,000 by the end of the accounting period on June 30, 2009. This will give rise to a non-trading deficit of £5,000.

In the same accounting period, Biggs & Co makes trading profits of £250,000. The £5,000 non-trading deficit could be set off against the trading profits to leave taxable trading profits of £245,000.


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