Offshore investment bonds have a key role to play in corporate financial planning. Companies can use bonds to provide the flexibility and control to shield investments from unnecessary tax. The current low interest rate economic cycle, combined with innovative ways of reducing risk and volatility, have made the offshore investment bond a vehicle to consider when compared to leaving company funds in deposit accounts.
Estimates for the size of company reserves held on deposit vary, but the Bank of England puts it at £284 billion. This exposure of cash to the erosive effects of inflation with currently nominal rates of interest being paid has led to company savings held on deposit being described as “lazy capital”. Utilising investment bonds held by the company can offer financial planning opportunities whilst the ability to guarantee capital can help companies overcome balance sheet conservatism and potentially see real growth in the assets held.
The way in which investment bonds held by a company are taxed is very different to the regime applied to private individuals. Since April 2008, they are taxed under the “Loan Relationship” rules, as opposed to the Chargeable Event legislation. Gains from an investment bond held by a company are deemed to be “non-trading credit” and losses are “non-trading debit”. The tax liability applicable under the loan relationship rules depends on which accounting method is applied by the company. A company may use a range of accounting standards, including ‘historic cost’, ‘fair value’ and “current cost”. So the first step in deciding whether to use an investment bond is to find out which accounting methods are being used.
1. “Fair Value” or “Current Cost” basis
The rise in the surrender value of the investment bond is deemed a non-trading credit and subject to corporation tax. This means some companies can take advantage of rolling up investment income and gains, allowing them to time corporation tax to coincide with when it is surrendered.
2. “Historic Cost” basis
The original amount invested in the bond is reported in the accounts. Taxable gains are only realised upon partial or full surrender of the investment bond. This gives the advantage of allowing investment gains to be deferred and gives an offshore investment bond the benefit of “gross roll up”. Encashment can be timed to coincide with years of losses to help reduce the corporation tax due on gains. Alternatively, if the investment bond makes a loss, this can be timed to be offset against company profits by making a full or partial surrender.
A few examples of how to utilise offshore investment bonds in corporate financial planning are listed below:
1. Shielding corporation tax on interest.
If a company bank account with an amount held on deposit of £100,000 pays interest at 1.5% per annum, the interest paid will be chargeable to corporation tax at the rate of 20% if the company makes a profit of £300,000 or less. This works out at £100,000 x 1.5% x 20% = £300.
If this deposit account was held in an offshore investment bond by a company using the “historic cost” basis, there would be no tax liable until a full or partial surrender of the bond, allowing interest to benefit from “gross roll up”.
2. Improving cash flow.
An investment bond can be used to keep company profits below the £1.5m corporation tax threshold which demands quarterly payments. Keeping profits below the £1.5m threshold would mean corporation tax was due nine months and one day following the end of the company’s accounting period, thus greatly improving the company’s cash flow.
3. Combine with pension planning.
The ability to defer a tax charge when using the “historic” accountancy standard can allow a company to realise a gain from the investment bond and simultaneously reduce profits liable to corporation tax through making a pension contribution in the same accounting period. This flexibility and control effectively allows for the deferral of a pension contribution which could be invaluable if the company requires access to the capital. Hence both access and tax efficiency are preserved since the pension contribution is offset against the company’s trading profits which creates a trading loss to offset against the investment bond gain.
- Care needs to be taken not to invest excessive amounts into an investment bond which could then restrict the company’s eligibility for Inheritance Tax Business Property Relief and Entrepreneurs Relief.
- If the size of a gain derived from the investment bond exceeds profits from the company’s usual trading activities, it could change the nature of the company to become a close investment-holding company and this would have taxation implications.
- The Loan Relationship rules men that unlike investment bonds held by private individuals, companies cannot utilise the 5% per annum cumulative withdrawals.
- A company’s Memorandum and Articles of Association need to be checked before taking out an investment bond to ensure there are no investment restrictions.