Tax implications for corporate investment

The two main drivers of investment performance for equity-based portfolios – capital gains and dividend yield – are impacted by:

• the rates of capital gains tax (CGT), being 20% for higher and additional rate taxpayers and 10% for basic rate taxpayers (if the gain when added to income is within the basic rate band);
• the CGT annual exemption for 2020/21 being £12,300; and
• the 0% £2,000 dividend allowance and 7.5% basic tax rate charged on dividends above the allowance.

This will, of course, be relevant for individuals with amounts to invest outside of the two most favoured “wrapped” investments, namely pensions and ISAs. Tax is not the “be all and end all” of investment return but getting it right so as to reduce its negative impact on return can certainly help.

As well as individuals, though, there are other investor types to consider, such as companies.

Companies

For corporate investors, the rates of tax on capital gains and dividends and the £2,000 dividend allowance, have no direct impact on investment decision making.

Companies don’t pay CGT. Capital gains realised by companies are subject to corporation tax, so whilst reductions in corporation tax have an impact on this aspect of investment decision making for companies, CGT rates do not.

Companies do, however, have special rules applicable to them when they invest (as many do of course) into investment bonds or interest based collective investments – the loan relationship rules. These rules, broadly, mean that, for companies that are not micro-entities, tax is based on any increase in value of the collective/investment bond from year to year, and on interest from the collective as it arises, and the tax due is paid annually, or, if the company’s profits are large enough, quarterly.

An interest distribution can be paid where, broadly speaking, more than 60% of the value of underlying investments of the collective, throughout the distribution period, is represented by qualifying interest-based investments. 

A micro-entity company would generally be unlikely to invest large amounts into collectives or investment bonds, because for a company to qualify either their balance sheet total or their turnover, or both where they have more than ten employees, have to be under £316,000 and £632,000 respectively.

Tax deferment of investment bond growth, for small companies, as opposed to micro-entity companies, can in theory apply where the investment bond is classed as a basic financial instrument and this requires strict adherence to four complex conditions, including being wholly invested in fixed income assets.

However, there is minimal, if any, tax deferral on an onshore investment bond holding fixed income assets as the insurer will have suffered up to 20% tax on the underlying fund income.

Looking at equity based investments, the dividend allowance and tax rates for dividends in excess of this are irrelevant for investments held by a company. Dividends received from UK equities and equity based collectives by a UK company will effectively be “franked” and will not be subject to any tax when received by the corporate investor (and any interest element within a dividend from an equity based collective is treated as having had 20% tax deducted from it, which can potentially be set off against the company’s tax bill.) This holds true regardless of the amount of dividends received.

Tax free dividends for companies – including UK life companies – is something that has been with us for some considerable time. It definitely has an impact on tax based decision making by individuals when considering the relative merits of UK life bonds and offshore bonds as the most tax efficient wrapper for reinvested dividends from an underlying portfolio of investments.

However, for corporate investors, investing in equity based investments through the medium of investment bonds can rarely make tax sense given that, for most companies, the loan relationship rules will apply to remove the benefit of tax deferment.

On the other hand, direct investment into UK equity based collectives can deliver tax free dividends and corporation tax on capital gains only on actual realisation (i.e. not annually, or quarterly, as might be the case for an investment bond or an interest based collective). Also, indexation allowance can be applied to capital gains up until 31 December 2017. 

Of course, advisers will have far more individual investors than corporate investors. For most the latter will be a comparative rarity.

Anyone advising a company on investment, before they consider the tax aspects, will need to consider the current and prospective future working capital needs of the business before committing any money to longer term investment.

Competing uses for available funds will also need to be considered – such as debt reduction/repayment or pensions. If any investment is to be made, an appropriate risk level will also need to be ascertained from the directors. And last, but certainly not least, careful consideration needs to be given to any impact that investment may have on the availability of business asset disposal relief (formerly known as entrepreneurs’ relief) on a subsequent sale of the business. 

Broadly speaking, serious consideration will need to be given if the amount to be invested exceeds 20% of the capital assets of the company. There are other (potentially ameliorating) aspects to take into account but the stated 20% test is definitely a starting point. 

If you or a client would like to discuss the topics covered in this article, why not get in touch and speak to one of our advisers.

The information in this article is correct as of 16/12/2020 and is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change. The Financial Conduct Authority (FCA) does not regulate taxation advice.

The value of investments can fall as well as rise. You may not get back what you invest.