Investment Companies – Reminder of Corporation Tax Treatment of Underlying Investments

Following the introduction of the additional rate of Income Tax, as well as the restriction for relief on finance costs in relation to residential rental properties, companies have become an increasingly popular vehicles through which to hold investments, both for growing wealth and as part of medium to long-term Inheritance Tax planning.

Although there are many other tax consequences to consider, given the numerous changes in both tax legislation and in accounting standards over the last 10 years, the Corporation Tax treatment often does not match the tax treatment that individuals or trusts are used to.

Please find below a summary of the general Corporation Tax treatment of some of the most common types of investments held within companies:

Type of Investment – Rental properties:

Income Profits

Rental income is subject to Corporation Tax with profits calculated on an accruals basis.

Company receives full Corporation Tax relief for any finance costs incurred.

Gains/Losses

Gains/losses are only chargeable to Corporation Tax when a property is sold.

Any gain/loss arising on a disposal is treated as a capital gain/loss. Any capital loss arising may only be offset against capital gains arising in the same or future periods.

Where a property was acquired prior to December 2017, Indexation Allowance, which is based upon the movement in the Retail Price Index, is still available for the period up to December 2017 to offset against any gain arising. It should be noted that Indexation Allowance can neither create nor increase a capital loss.

Type of Investment – Shares:

Income Profits

Any dividend distributions are generally exempt from Corporation Tax.

Gains/Losses

Gains/losses are only chargeable to Corporation Tax when shares are sold.

Any gain/loss arising on a disposal of shares is treated as a capital gain/loss. Any capital loss arising may only be offset against capital gains arising in the same or future periods.

Where the company owns broadly a 10% or more interest in the shares in a trading company for more than 12 months, any gain/loss arising may be exempt from Corporation Tax.

Otherwise, where shares were acquired prior to December 2017, Indexation Allowance, which is based upon the movement in the Retail Price Index, is still available for the period up to December 2017 to offset against any gain arising. It should be noted that Indexation Allowance can neither create nor increase a capital loss.

Type of Investment – Real Estate Investment Trust (REITs)

Income Profits

REITs typically make two different types of distribution:

• Dividends, and
• Property Income Distributions (PIDs)

Any dividend distributions are generally exempt from Corporation Tax.

Any PIDs are treated as property income subject to Corporation Tax, although the 20% Income Withholding Tax may be able to be offset against any Corporation Tax liability arising.

Gains/Losses

Gains/losses are only chargeable to Corporation Tax when shares in a REIT are sold.

Any gain/loss arising on disposal is treated as a capital gain/loss. Any capital loss arising can only be offset against capital gains arising in the same or future periods.

Otherwise, where the REIT shares were acquired prior to December 2017, Indexation Allowance, which is based upon the movement in the Retail Price Index, is still available for the period up to December 2017 to offset against any gain arising. It should be noted that Indexation Allowance can neither create nor increase a capital loss.

Type of Investment –  Treasury Stock/ Corporate Bonds/ Loan Stock

Any income arising is treated as interest subject to Corporation Tax.

Gains/Losses

Gains/losses are subject to Corporation Tax as they are recognised within the financial statements.

This means that gains/losses may be chargeable/relievable for Corporation Tax purposes before the investments are sold.

Type of Investment –  Open Ended Investment Companies (OEICs)/ Unit Trusts (UTs)

Income Profits

The tax treatment of these investments is generally dependent upon the underlying investments held within the individual OEIC/UT.

Where the underlying investments comprise 60% or more of cash/Treasury Stock/Corporate Bonds/Loan Stock/Other Similar Investments, the OEIC/UT, the investment is generally taxable in the same manner as Treasury Stock/Corporate Bonds/Loan Stock with any distributions being treated as interest subject to Corporation Tax.

Where the underlying investments do not meet this 60% test, the investments are generally treated as normal shares with any distributions normally being treated as dividend distributions and exempt from Corporation Tax.

Gains/Losses

As with income profits, the treatment of gains/losses is generally dependent upon the 60% underlying investments test.

If the underlying investments meet the 60% underlying investment test, any gains/losses generally follow the same treatment as that for Treasury Stock/Corporate Bonds/Loan Stock as outlined above.

If the underlying investments do not meet the 60% test, any gains/losses generally follow the same treatment as that for Shares as outlined above.

As different accounting standards have different requirements as to how to the value of investments needs to be recognised within a set of company financial statements, depending upon the preferred investment, this can potentially have a significant knock-on effect as to when any Corporation tax liabilities may arise.

 

As a final point, with the return to a main rate (25%) and small profits rate (19%) of Corporation Tax with effect from 1 April 2023, where more than 50% of an investment company’s shares are held by connected persons (typically family members) and the company’s only activities are investing in a combination of shares (other than where they are shares in a subsidiary), REITs, Treasury Stock, Corporate Bonds, Loan Stock, OEICs, UTs, or other similar investments (i.e. not property), the company may be considered a Close Investment Holding Company. Where this is the case, the company will be subject to Corporation Tax at the main rate (25%) regardless as to the level of any taxable profits.

Please note that the above is only a general outline of the Corporation Tax treatment of some of the more common types of investments. This article does not constitute advice on how you should invest your money nor the suitability of such investments. Should you require any further information, please do not hesitate to contact us.