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Corporate owned bonds – corporation tax

23 min read 4 Apr 22

Corporation tax implications of a company investing in an Investment Bond or OEICs. 
  • Companies commonly hold cash on the balance sheet that is surplus to working capital requirements. This can arise when the accountant and the company stakeholders have agreed not to fully extract profits by way of dividend, remuneration or employer pension contributions. This surplus may be earmarked to fund a future business project or it may simply be a cash buffer to help weather the economic climate.

  • With interest rates at very historically low levels, company stakeholders are increasingly seeking a better return for that surplus cash.

  • If an accountant has prepared the accounts reflecting those surplus funds, then a financial adviser’s role is to advise on how those surplus funds might be better invested.

  • UK and Offshore Investment bonds, and OEICs, offer an investment vehicle for corporate money.

  • With a bond wrapper, the company stakeholders may be able to enjoy multi asset investments with a smoothing process to protect them from short term volatility. They will not benefit from the full upside of any stock market rises, but crucially they will not suffer from the full effects of any downsides. For directors acting as custodians of shareholder funds, this peace of mind can be invaluable.

For a variety of reasons, it is common for a company to hold cash on the balance sheet surplus to working capital requirements. The company will receive gross interest from the bank and pay corporation tax annually on the interest earned. But, with interest rates at very low levels, companies are increasingly seeking a better return for that cash. Low volatility is generally important as those funds will be required for business purposes at some point. 

Spring Budget 2021 introduced a three-pronged approach to corporation tax in the future. 

  1. Corporation tax is 19% for the financial years starting 1 April 2020, 1 April 2021 and 1 April 2022.

  2. From 1 April 2023, the headline (i.e. main) corporation tax rate will be increased to 25% applying to profits over £250,000.

  3. A small profits rate (SPR) will also be introduced for companies with profits of £50,000 or less so that they will continue to pay Corporation Tax at 19%. Companies with profits between £50,000 and £250,000 will pay tax at the main rate reduced by a marginal relief providing a gradual increase in the effective Corporation Tax rate.

The SPR will not apply to close investment-holding companies. An example would be a company controlled by a small number of people which doesn’t exist wholly or mainly for the purpose of trading commercially or investing in land for (unconnected) letting. A Family Investment Company might therefore be an example of a company not eligible for the SPR.

A company with profits falling between £50,000 and £250,000 will pay corporation tax at 25% but then reduced by marginal relief which results in a gradual increase in the corporation tax rate as profits increase from £50,000 until the 25% rate kicks in. The marginal relief fraction is 3/200 and works as follows.

Note in the examples below of ABC Ltd and DEF Ltd, taxable profits are £51,000 and £100,000 respectively. If ‘augmented’ profits are higher, that higher figure should be used in the calculation. Broadly, augmented profits are taxable profits plus any exempt distributions received (excluding dividends from 51% subsidiaries).

ABC Ltd – year to 31 March 2024 

   

£

Taxable profits £51,000

 

                 

Corporation Tax @ 25%

 

£12,750                     

Marginal Relief

3/200 x £250,000 less £51,000

(£2,985)

Tax due

 

£9,765

Effective rate

£9,765 / £51,000

19.15%

 

DEF Ltd – year to 31 March 2024 

 

   

£

Taxable profits £100,000

   

Corporation Tax @ 25%

 

£25,000

Marginal Relief

3/200 x £250,000 less £100,000

(£2,250)

Tax due

 

£22,750

Effective rate

£22,750 / £100,000

22.75%

 

Take DEF Ltd, a quicker way of approaching the corporation tax calculation is simply to tax £50,000 at 19% = £9,500 plus £50,000 @ 26.5% = £13,250. The total of £22,750 agrees with the tax due in the table which used the marginal relief fraction approach. 

The corporation tax liability of DEF Ltd is £12,985 more than the corporation tax liability of ABC Ltd. Given that the taxable profits of DEF Ltd are £49,000 more than ABC Ltd, then we can calculate that each £1 of profit between £50,000 and £250,000 is taxed at an effective marginal rate of 26.5% (£12,985/£49,000 x 100). Both these companies could consider employer pension contributions to reduce taxable profits to £50,000 and potentially benefit from 26.5% corporation tax relief.

The lower and upper limits will be proportionately reduced for short accounting periods and where there are associated* companies. For example if a company has one associated company the upper profits limit is £125,000 and the lower profits limit is £25,000

* A company is an 'associated company' of another company if one of the two has control of the other, or both are under the control of the same person or persons.

The corporation tax changes are applicable from 1 April 2023 i.e. Financial Year 2023 which ends on 31 March 2024. A company however pays tax on the profits for an accounting period and if the accounting period spans 1 April 2023, then profits will be apportioned between those falling within the financial year 2022, (taxed at 19%), and those falling within the financial year 2023.

Example – Accounting period to 31 December 2023. Taxable profits £1,000,000 

Accounting period

Profits

Rate

01/01/23 - 31/03/23

90/365 x £1,000,000 = £246,575

19%

01/04/23 – 31/12/23

275/365 x £1,000,000 = £753,425

25%

The Chancellor has stated that around  70% of companies (1.4m businesses) will be completely unaffected, and just 10% will pay the full higher rate. For the 30% that are impacted then these looming corporation tax increases will begin to focus minds, and might influence behaviours.

Assume a company draws up accounts to 31 December each year. If so, the accounting period 1 January 2022 to 31 December 2022 will be the last one that isn’t impacted by the new regime. Corporation tax planning may now involve, if possible, accelerating  income or gains to accounting periods ending before 1 April 2023 instead of those amounts being taxed under the less favourable Financial year 2023 regime (see comments below relating to crystallising bond or OEIC gains in certain circumstances). Less beneficial, but still worthy of consideration, would be accelerating income or gains to an accounting period straddling 1 April 2023 so that if, for example the accounting period was 1 January 2023 to 31 December 2023 then at least 90/365 (i.e. 3/12) of the profits would benefit from the current 19% corporation tax regime.

In addition to accelerating income or gains, directors might consider delaying tax allowable expenditure so that it falls under the forthcoming regime.

Regarding corporate owned bonds, as set out below, a ‘micro entity’ uses historic cost accounting for an insurance bond. The company achieves tax deferral until there is a disposal event such as full surrender, and assuming a gain arises, that profit is taxed at the prevailing corporation tax rates. If it’s a UK bond then the company enjoys a 20% tax credit which more than wipes out 19% corporation tax currently due on the bond gain. For Historic Cost companies, consideration may be given to crystallising the gain while the 19% rate applies and reinvesting those proceeds. For those bigger companies using fair value accounting then tax on growth is paid on an annual basis and so, on an ongoing basis, annual investment gains will automatically attract those 19% rates until April 2023. For those fair value companies holding offshore bonds there is therefore no need to crystallise any deferred gains to protect them from higher tax as the gains have been taxed as they go along.

There is however a quirk with fair value companies holding onshore bonds. Annual gains on the bond are taxed on a net basis and these will have been taxed at 19%. However, when a surrender happens the net gain is grossed up due to the 20% tax credit. This means that the difference between the current gross gain and net gains that have already been taxed could be deferred into a higher taxpaying regime, in a similar way to the whole gains for micro entities above. The additional tax payable on deferral will be between 6% and 7.5% of 25% of the accumulated net gains. Like those smaller companies consideration should be given to crystallising those gains and reinvesting to prevent profit being deferred into a higher tax regime. This analysis should be checked with the accountant before any action is taken.

For both types of company when looking at crystallisation and reinvestment, consideration should be given to whether the costs of doing so will be higher than the tax savings – a “self-defeating transaction”. 

Note that these corporation tax measures do not impact the 20% ‘tax credit’ on UK bonds available to individuals, trustees and corporate investors. In other words, life assurance fund taxation is not impacted.

With regard to existing OEICs, whether “equity or interest funds”, held by a micro entity, gains are taxed at time of disposal (not annually) and so again directors might expedite the disposal of shares in OEIC funds to crystallise the gain while subject to potentially lower corporation tax rates.

For non-micro companies, ‘equity funds’ (see later) are also taxed on disposal and therefore again the disposal might be brought forward to crystallise the gain at lower corporation tax rates. Note however ‘interest funds’ held by non-micro companies are accounted for under fair value rules meaning they are revalued and taxed annually. On an ongoing basis, gains therefore automatically attract those 19% rates until April 2023.

Note that planning with the new corporation tax regime in mind might lead to directors considering the option of not retaining and investing surplus cash within the company, but instead extracting the surplus funds and perhaps directors/shareholders then investing personally. Bear in mind however that although it’s possible to  accurately calculate the tax cost of extracting funds for personal benefit at a particular point in time, it is then not possible to accurately calculate whether a corporate investment or a personal investment ultimately yields the better return as future corporation tax and personal tax changes will influence matters. An educated estimate is the best that can be achieved.

These thoughts however spring to mind.

Advantages of investing surplus cash remaining within the company? 

  • The accountant and the company stakeholders may have taken the conscious decision to keep these surplus funds inside the business as a nest egg or because the funds are earmarked for a particular business purpose in the medium term.
  • It may be desirable to keep funds in the company to maintain a strong Balance Sheet.
  • It is possible that excess funds inside the company are sheltered from IHT as they are required for a palpable business purpose but fall into the IHT net once personally owned.
  • Dividends paid out from after tax profits might be more tax efficient than remuneration paid, but that can lead to complications if multiple shareholders are involved. Is it desirable that all shareholders receive a dividend? If not dividend waivers are an option but anti-avoidance legislation can apply in certain situations.
  • Directors of a company which is planning to cease trading may wish to invest within the company and then gradually extract funds tax efficiently over a number of years.
  • If taxable investment growth arises within the company, the accountant may be able to mitigate the corporation tax impact by careful timing of tax allowable expenditure charged through the accounts. Paid employer pension contributions perhaps.
  • The gross amount of surplus cash can be invested within the company as corporation tax has already been suffered. If the surplus cash is extracted by way of remuneration or dividend, then the recipient’s personal tax liability on that sum will mean that only the net amount is available for personal investment.
  • The tax on interest, dividends and gains may be lower within the corporate entity than if held personally
  • Where the company cash will be used as a future income stream the money may be extracted at a lower tax rate in future than that payable now.

Advantages of extracting the funds and then investing personally? 

  • The director/shareholder recipient can use the funds to carry out IHT planning (e.g. implement a bond in trust solution).
  • If the director/shareholder has a spouse or civil partner, then it may be possible to gift funds to the other partner to enjoy two lots of rates, bands and allowances applying to the investment returns.
  • If the company invests, then a gain in a particular accounting period will increase taxable profits and could lead to an increased corporation tax rate applying to all the profits in that period i.e. not just on the investment gain.
  • Certain directors/shareholders might have particular reasons why they would prefer to receive extracted funds now rather in the future e.g. family circumstances, purchase of new property etc.
  • For some, cash in hand is preferable to cash in the company.
  • The personal taxation on any investments could be lower than that which would be suffered in the company.

Investment Bonds and ‘interest’ OEIC funds owned by companies are taxed under the 'loan relationship' rules, the remit of which extends well beyond insurance bond and OEICs. ‘Equity’ OEIC funds do not however fall within the these rules.

Although complex in nature, in very broad terms, these rules require the taxation treatment of the item in question (in this case an insurance bond or an interest OEIC fund) to follow the accounting treatment.

OEICs are dealt with later in the article. For now the focus is on Investment Bonds

To understand the tax treatment of a corporate owned investment bond, it is therefore necessary to consider the accounting treatment. There are a number of accounting standards that a company might use – principally historic cost and fair value.

The bond is simply shown in the balance sheet at the end of the company's accounting period at the original premium amount, regardless of the actual surrender value. No annual gain (or loss) is recognised in the company accounts, meaning no corporation tax consequences arise. The company achieves tax deferral until there is a disposal event such as full surrender, partial surrender or death of last life assured. 

In this case, the balance sheet at the end of the accounting period will include the bond at its surrender value at that date. That means the movement in value (either a gain or loss) has been processed through the profit and loss account. That movement has corporation tax consequences. The company does not achieve tax deferral since the increase in value will be subject to corporation tax (any decrease is potentially relievable for corporation tax purposes).

‘Micro entities’ can use historic cost accounting for insurance bonds. Larger companies use fair value rules when accounting for insurance bonds.

It had been the case previously that 'small' companies used historic cost, with large companies obliged to use fair value. The reason for this was that small companies used a set of less complicated accounting standards known as the Financial Reporting Standard for Smaller Entities (FRSSE) which permitted historic cost accounting. FRSSE was however withdrawn, meaning the majority of large and medium-sized UK entities now apply FRS 102 (see below) when preparing their annual financial statements. As mentioned above, ‘micro entities’ e.g. contractor type companies, will use historic cost accounting for insurance bonds.

With a micro entity being small in size, it can enjoy the least complex and comprehensive financial reporting requirements possible by applying FRS 105. Overall, the financial accounts will be straightforward, require limited disclosure of information and will be constrained as regards accounting policies. In particular, no assets can be measured at fair value or a revalued amount. In other words, historic cost will apply. Note that the company may opt up to a more comprehensive accounting regime if it considers that FRS 105 doesn’t meet its needs.

Accounting standards are complex and the recognition of the bond in the accounts is, in every case, a matter for the accountant to determine. 

FRS 102 is the main UK Generally Accepted Accounting Practice (GAAP) standard.

FRS102 replaced over 70 accounting standards and Urgent Issues Task Force interpretations, spanning more than 2,400 pages with one succinct standard of a little over 300 pages. It reflects developments in the way businesses operate and uses up-to-date accounting treatment and language. In short, FRS102 is concerned with wider issues than insurance bonds.

While format requirements of the Companies Act remain, in many cases the terminology used in FRS 102 differs from old UK GAAP. For example, a profit and loss account is now an "income statement" under FRS102, and a balance sheet is a "statement of financial position".

Under FRS102, "basic financial instruments" (see the definition of basic financial instruments below) can be valued at historic cost but a typical insurance bond would not fall within the definition. Insurance bonds falling outside the definition of a 'basic financial instrument' will be accounted for under the fair value regime.

When the company makes a part or full disposal, this is called a 'related transaction'. The profit (or loss) on that is treated as a non-trading credit (NTC) or a non-trading debit (NTD). Where the bond in question is a UK bond, then relief is obtained for the basic rate tax deemed paid within the fund. This amounts to 25% of the NTC profit on disposal. That amount can be offset against the company's overall corporation tax liability for the accounting period in question. If it exceeds the company's tax liability then the excess is not repayable and neither can it be set off against any prior or future accounting periods. 

The implications of FRS102

Where the company is using fair value accounting with a UK bond, then annual increases in value are taxable despite the fact that the underlying life fund is subject to tax. In other words, that net growth is taxed. The ‘tax credit’ on the UK bond does not apply on those annual increases but instead it only applies on a subsequent disposal. Directors should be aware therefore that double taxation initially occurs on those annual increases i.e. life fund tax suffered and also corporation tax paid by the investing company on that net return. The benefit of the ‘tax credit’ on disposal rectifies that, but it should be noted that the credit can only be offset against the company's overall corporation tax liability for the accounting period in question. If the credit exceeds the company's tax liability then the excess is not repayable and neither can it be set off against any prior or future accounting periods. Therefore for a company which encashes the bond in an accounting period in which there are no other profits and no corporation tax liability, then the benefit of that tax credit might be lost. Therefore, for those ‘fair value’ companies concerned about ‘fluctuating’ results and potentially wasting a tax credit in the accounting period of disposal, then an offshore bond may be the solution. The investing company simply pays tax annually on a gross return (i.e. gross roll-up within the fund) with no tax credit on disposal. The taxation of offshore bonds for fair value and historic cost companies are considered below. 

There is a category of businesses called ‘small entities’. A company will qualify if it does not exceed two or more of the following criteria: 

  • Turnover: £10.2m
  • Balance Sheet: £5.1m
  • Number of employees: 50

These entities are required to use the FRS102 accounting rules outlined above (i.e. fair value for a typical insurance bond) but have reduced presentation and disclosure requirements 

Very small companies (e.g. contractor type companies) can continue with historic cost. A company qualifies if it doesn’t exceed two or more of the following criteria: 

  • Turnover: £632,000
  • Balance Sheet total: £316,000
  • Number of employees: 10

Under this regime, no assets can be measured at fair value or a revalued amount and instead must be held at cost. 

No. Following Finance Act 2008, the loan relationship rules apply and not chargeable event gain rules (5%s do not apply to companies). As mentioned above, the loan relationship rules have a much wider remit that just investment bonds. 

The examples below consider a company investing in a UK bond. If however the company invests offshore then the position is as follows. 

In the same manner as a UK bond, under fair value rules, any increase in value will be subject to corporation tax with any decrease potentially relievable for corporation tax purposes. When the company makes a full or part disposal and a profit arises, there will be no grossing up of that profit required and accordingly no tax treated as paid for offset against the company’s corporation tax liability. This is logical, as that mechanism is in place simply to give the company a measure of relief similar to the basic rate tax treated as paid on chargeable event gains on UK policies owned by non-corporates (i.e. individuals and trustees). The potential ‘double taxation’ problem that could arise with a UK bond, as mentioned above, will not apply.

If a micro entity invests in an offshore bond, then how is that taxed under historic cost rules? As with a UK bond, no annual gain (or loss) is recognised in the company accounts, meaning no corporation tax consequences arise. When the company makes a full or part disposal and a profit arises, then no ‘basic rate’ adjustment mechanism is required and that profit is simply at the prevailing corporation tax rates.

Assume that in each accounting period Fair Value Ltd has taxable profits of £100,000 before any bond gains are included.

The company has an accounting date of 31 March. In September 2021 it invests £200,000 in a UK bond which is valued at £220,000 by 31 March 2022. 

 

Accounting Period Ended (APE) 31 March 2022 - bond valued at £220,000 

- Non-trading credit (NTC) £20,000 x 19% = £3,800

The 19% corporation tax rate does not vary depending on the level of taxable profits

 

APE 31 March 2023 - bond valued at £215,000 

- Non-trading debit (NTD) £5,000 (no tax payable)

In October 2023 the company surrenders 50% for £120,000 when the bond is worth £240,000. By 31 March 2024, the bond is valued at £127,500

 

APE 31 March 2024 

50% of bond surrendered for proceeds of    £120,000

50% of value at 31 March 2023                   (£107,500)

NTC on part surrender                                 £12,500

Also there is an overall profit of £20,000 (50% yielded proceeds of £120,000 yet 50% of premium cost £100,000). Gross up @ 100/80 = £25,000. Therefore tax credit = £5,000

Annual movement £127,500 less 50% of £215,000 = £20,000

Total NTCs £12,500 + £5,000 + £20,000 = £37,500
@ 26.5% effective rate                              =£9,937
Tax credit                                                    (£5,000)
Tax due                                                        £4,937

Now let's assume that Fair Value Ltd encashes the bond in April 2024 for £127,500. The bond has therefore not changed in value since 31 March 2024. This disposal occurs in APE 31 March 2025.

The full surrender is called a 'related transaction'. This means we recognise the fact that the life fund has suffered tax at a rate equal to basic rate.

We must calculate 'PC' which is the profit from the contract.

PC equals proceeds of £127,500 less £100,000 (50% of original cost) = £27,500

PC is also obtained by summing the previous NTCs & NTD = £20,000 less £5,000 plus £12,500 = £27,500

PC must be grossed up to reflect the tax suffered within the fund 

  • £27,500 x 100/80 = £34,375
  • £34,375 - £27,500 = £6,875 (this is a NTC)

Corporation tax due on the NTC = £6,875 x 26.5% = £1,822

Tax treated as paid                                             = (£6,875)

Available for offset                                             = £5,053

Overall reconciliation 

The company invested £200,000 and it has received proceeds of £120,000 plus £127,500. Total gain therefore of £47,500. Given this is a UK bond, then the company enjoys the benefit of the 20% deemed tax suffered within the fund. This is demonstrated by the following summary which shows that in net terms the overall corporation tax liability is £2,734.

31 March 2022 -  £3,800 tax paid

31 March 2023 - (£950) tax relieved against other profits

31 March 2024 -  £4,937 tax paid

31 March 2025 - (£5,053) tax relieved against other profits

Total                       £2,734

The figure of £2,734 is reconciled as follows. If we gross up the total gain of £47,500 by 100/80 then the figure is £59,375. Taxed at 19% is £15,000 (£20,000 less £5,000) and taxed at 26.5% is £44,375 (£37,500 plus £6,875) = £14,609. Deduct the tax credit of £11,875 to arrive at £2,734. 

Let's now consider the exact same bond purchased and surrendered as was the case for Fair Value Ltd, but let's assume a micro entity using historic cost accounting.

Micro Entity Ltd also has an accounting date of 31 March. In September 2021 it too invests £200,000 in a UK bond. In October 2023 it also surrenders 50% for £120,000 when the bond is worth £240,000. And it also encashes the bond in April 2024 for £127,500.

Assume that in each accounting period Micro Entity Ltd has taxable profits of £100,000 ignoring any bond gains.

APE 31 March 2022 – changes in value during an accounting period are not recognised under historic cost accounting. Therefore no tax consequences.

APE 31 March 2023 – changes in value during an accounting period are not recognised under historic cost accounting. Therefore no tax consequences.

APE 31 March 2024 – gain of £20,000. Grossed up at 100/80 = £25,000. Taxed at effective rate of 26.5% = £6,625 less the onshore bond tax credit of £5,000 = tax due of £1,625.

APE 31 March 2025 – gain of £27,500. Grossed up at 100/80 = £34,375. Taxed at an effective rate of 26.5% = £9,109 less the onshore bond tax credit of £6,875 = tax due of £2,234.

Micro Entity Ltd is therefore paying corporation tax in total of £1,625 + £2,234 = £3,859. This exceeds the £2,734 paid by Fair Value Ltd. Why is Micro Entity Ltd paying £1,125 more corporation tax than Fair Value Ltd when both companies made an overall gain of £47,000? The reason for the difference is that Fair Value Ltd crystallised net gains of £15,000 at 19% but Micro Entity’s gains were all crystallised at an effective rate of 26.5%. In other words, £15,000 @ 7.5% (26.5% less £19%) = £1,125. 

An insurance bond would need to satisfy the following conditions contained in 11.9 of FRS102

(a) Returns to the holder are:

(i) a fixed amount;

(ii) a fixed rate of return over the life of the instrument;

(iii) a variable return that, throughout the life of the instrument, is equal to a single referenced quoted or observable interest rate (such as LIBOR); or

(iv) some combination of such fixed rate and variable rates (such as LIBOR plus 200 basis points), provided that both the fixed and variable rates are positive (eg an interest rate swap with a positive fixed rate and negative variable rate would not meet this criterion). For fixed and variable rate interest returns, interest is calculated by multiplying the rate for the applicable period by the principal amount outstanding during the period.

(b) There is no contractual provision that could, by its terms, result in the holder losing the principal amount or any interest attributable to the current period or prior periods. The fact that a debt instrument is subordinated to other debt instruments is not an example of such a contractual provision.

(c) Contractual provisions that permit the issuer (the borrower) to prepay a debt instrument or permit the holder (the lender) to put it back to the issuer before maturity are not contingent on future events other than to protect:

(i) the holder against the credit deterioration of the issuer (eg defaults, credit downgrades or loan covenant violations), or a change in control of the issuer; or

(ii) the holder or issuer against changes in relevant taxation or law.

(d) There are no conditional returns or repayment provisions except for the variable rate return described in (a) and prepayment provisions described in (c).

Clearly an investment bond does not satisfy the conditions. 


In addition to non-income producing Investment Bonds, companies may purchase shares in an OEIC fund where the company will receive dividend distributions or interest distributions. In each distribution period an OEIC fund must distribute the total amount available for distribution shown in the accounts as available for distribution to investors in proportion with their rights.

If the company holds accumulation shares, then income arising within the fund during a distribution period is not distributed and so it will not hit the company bank account as cash. The income is instead retained in the fund as an additional capital investment on behalf of the company but without the issue of any additional shares. Amounts reinvested are subject to corporation tax in the same way as if they had been distributed.

When a dividend distribution is made by the OEIC fund, then in the hands of the recipient company,  part of the distribution is treated as interest (i.e. ‘unfranked’). That part is subject to corporation tax. The remaining (‘franked’) part of the dividend distribution is treated by the recipient in the same manner as applies for other UK company dividends i.e. tax free.

Why does this treatment apply to corporate investors but not individuals and trustees? It exists to ensure that the company’s share of taxable income arising from the OEIC fund is not treated as tax free dividend income in the hands of the company. This treatment is known as ‘corporate streaming’. The provider is required to inform the investing company of the streamed distribution figures.

Where an interest distribution is made by the OEIC fund, no streaming applies and therefore the recipient company is treated as receiving gross interest as a loan relationship credit.

The OEIC fund can pay an interest distribution only if it satisfies the ‘qualifying investments’ test throughout the distribution period. Where the qualifying investments test is not satisfied then a dividend distribution is made.

Test for the OEIC fund paying interest 

This test must be satisfied by any OEIC fund in order to make an interest distribution. An OEIC fund satisfies the qualifying investments test if at all times throughout the distribution period the market value of its qualifying investments exceeds 60% of all its investments. Qualifying investments either yield interest or, whilst not being interest, give returns whose economic substance is of a similar nature. 

OEIC distributions – summary 

  • If OEIC fund passes the 60% test it distributes interest which is taxable on the recipient company. No streaming occurs.
  • If OEIC fund doesn’t pass the 60% test, it pays dividends. But, under the streaming process, part of the distribution is treated as taxable interest by the recipient company and part as tax free dividend. The provider is required to inform the company of the relevant figures.

If the OEIC fund has qualifying investments which have a market value over 60% of the fund’s total assets, then the loan relationship rules apply. Therefore, a fund which is able to make interest distributions will always fall under the loan relationship rules. That means (non-trading) credits and debits will be taxed in accordance with GAAP. 

OEIC growth – summary 

  • For a  Micro entity using historic cost accounting, both equity and interest OEICs will be shown in the balance sheet at the end of the company's accounting period at the original investment, regardless of the actual value. No annual gain (or loss) is recognised in the company accounts, meaning no corporation tax consequences arise on growth. The company will not be taxed on growth until time of disposal.
  • For a larger company using fair value accounting then for interest type funds the balance sheet at the end of the accounting period will include the OEIC fund at its value at that date. That means the movement in value (either a gain or loss) has been processed through the profit and loss account. That movement has corporation tax consequences. The company does not achieve tax deferral since the increase in value will be subject to corporation tax (any decrease is potentially relievable for corporation tax purposes).
  • For a larger company using fair value accounting then for non-interest funds (i.e. equity type funds) the balance sheet might reflect any growth but if it does so it will not be taxed until time of disposal because the loan relationship rules do not apply i.e there is no requirement for the tax treatment to follow the accounting treatment.

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