Corporate investment - Onshore and Offshore Insurance Bonds and OEICs - ten common questions

The company will be the applicant/owner.

A Life Assurance Bond requires a life/lives assured - typically directors whose death would cause financial detriment to the company.

Example of an Onshore Bond application

A non-trading, investment company might not be able to demonstrate insurable interest and therefore an Offshore Capital Redemption Bond requiring no lives assured could instead be used.

The chargeable event rules applicable to individuals, trustees and personal representatives don’t apply to companies (so, no 5% rule!). Instead, the ‘loan relationship’ rules apply which have a much wider remit than just investment bonds. Although complex, in broad terms, the rules require the taxation treatment of the item in question (i.e. the Bond) to follow the accounting treatment. There are different accounting standards that a company might use but typically, ‘micro entities’ will use historic cost accounting with larger companies using fair value rules.

Qualifying rules for a micro entity

The accounting method should be clear from the accounts, and the accountant will, of course, confirm.

Micro entities are very common. Think of an IT or medical contractor for example.

With a micro entity being small in size, it can enjoy ‘simple’ accounting methods by applying Financial Reporting Standard (FRS) 105. In particular, the Bond will not be measured at fair value (see below) and instead historic cost will apply.

Historic Cost example

The majority of large and medium-sized UK entities apply FRS 102 when preparing accounts. Under FRS102, "basic financial instruments" can be valued at historic cost but a typical Insurance Bond won’t meet that definition. Therefore, Insurance Bonds are typically accounted for under the fair value regime.

Fair Value example

Yes.

The company is treated as having paid 20% tax on the gain arising on a disposal event. In practice the effective rate of tax within the fund will be lower - bear in mind that dividends received within the fund are tax exempt. The 20% deemed paid can be set against the company’s corporation tax liability for the accounting period in question.

This does not apply to annual gains arising on Onshore Bonds for companies using fair value accounting. However, the above rule does reflect the earlier gain by allowing subsequent relief when there is a disposal event.

Where the 20% tax credit on a disposal event exceeds the company’s tax liability, the excess is not repayable or offsetable in any other accounting period. If the tax credit is lower than the corporation tax liability then further tax is payable.

For a micro entity using Historic Cost accounting, no annual gain (or loss) is recognised in the accounts, meaning no tax consequences arise regardless of Onshore or Offshore. When there is a ‘disposal event’ there is however a difference. With an Onshore Bond, the gain is grossed up at 100/80 to reflect the 20% credit. The gross amount is taxed at the prevailing corporation tax rate with the 20% tax credit available to offset against that. With an Offshore Bond, because the company has enjoyed ‘gross roll-up’ then that gain will not be grossed up and the company will pay corporation tax at the appropriate rate on the gain.

Both Onshore and Offshore Bonds have their own merits for micro entities.

From 1 April 2023, the corporation tax main rate increased to 25% for profits over £250,000. A small profits rate was also introduced for certain 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. These corporation tax changes are explored here.

Onshore and Offshore Bond annual increases in value are taxable despite the underlying life fund with an Onshore Bond being subject to tax. The ‘tax credit’ with a UK bond doesn’t apply on those annual increases but does apply on a subsequent disposal event. Effectively therefore, double taxation occurs on those annual increases i.e. life fund tax and corporation tax paid by the company on that net return. The benefit of the ‘tax credit’ on disposal rectifies that, but the credit can only be offset against the company's overall tax liability for the accounting period in question. If the credit exceeds the tax liability, the excess is not repayable and neither can it be set off against any prior or future accounting periods. Therefore for a company encashing the bond in an accounting period in which there is no corporation tax liability, then the benefit of that tax credit would be lost.

For directors of ‘fair value’ companies with fluctuating profits, concerned about potentially wasting a tax credit in the accounting period of disposal, then an Offshore Bond is the solution. The company pays tax annually on a gross return (i.e. gross roll-up within the fund) with no tax credit to consider.

In contrast to a non-income producing Bond, an OEIC must distribute income.

If the fund is more than 60% invested in interest paying assets then it will pay interest. If not, it will pay tax exempt dividends. Does this present an opportunity for a corporate investor - invest in a fund which falls short of the 60% rule so that it pays dividends thereby turning taxable interest into tax free dividends?

No. Where a company invests in an OEIC fund paying dividends then the rule is that the provider ‘streams’ the distribution so that the company will be informed that X% is tax free dividend & Y% is taxable interest.

What about capital growth?

Example of micro entity using historic cost accounting

Example of a larger company using fair value accounting

For shareholders in private companies which are not wholly or mainly carrying on investment activities, then Business Relief, or Business Property Relief (BPR) can give 100% relief from IHT. Tax rules prevent shareholders getting relief for non-business assets and so, the value of ‘excepted assets’ is ignored when calculating BPR. Excess surplus cash can be an excepted asset if it hasn’t been used wholly or mainly for business purposes throughout the two years prior to the transfer of value. Or, it’s not required for a palpable future business use.

Pointers on excess cash

BADR which was formerly known as Entrepreneurs’ Relief can deliver a Capital Gains Tax rate of just 10% for directors selling shares in a trading company. Tax law defines a ‘trading company’ as one which doesn’t carry on non-trading activities to a substantial extent. HMRC consider ‘substantial’ in this context means more than 20%. Therefore, for BADR to be potentially available, non-trading activities must be no more than 20% of total activities.

Measures or indicators should be considered. For example

• Income from non-trading activities.
  
  
• Time spent by directors looking after investment activities.
  
  
• The company’s asset base.

These indicators are not individual tests, but should be applied “in the round”. However, in the context of a Bond for example, the “asset base” test (alone) might be conclusive since it is non-income producing and doesn’t use up directors’ time like a property letting portfolio for example might do so.

As a rule of thumb, investing will not count as a trading activity albeit that the short-term lodgement of surplus funds, for example in a deposit account, could count as a trading activity. In saying that, the long-term retention of significant earnings generated from trading activities may amount to an investment.

For business owners contemplating a disposal of shares, the accountant will carefully monitor compliance with the 80/20 split so as not to risk losing relief. In many cases however, the surplus cash balance sits comfortably within that 20% limit meaning no impact on the relief.

The qualifying conditions must be satisfied for at least two years before disposal.

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