Corporate Owned Bonds

by on 09·08·2016

You don't need to be Mark Carney to realise that interest rates are likely to stay low for some time.

This leaves companies holding large amounts of cash with a conundrum. The returns on cash are poor, an unescapable fact. If companies invest, low volatility is probably ideal as it is likely the funds may be needed for business purposes at some point. There are various options available, of course, but we are often asked about the suitability of investment bonds for company investments.

We all know the merits of an investment bond per se and the basic rules of the corporation tax regime. However, the tax implications of a corporate owned bond needs further investigation.

Effectively they are taxed under the 'loan relationship' rules. As you can imagine the raft of legislation on this is complex and thus, to simplify, the tax of the investment simply follows the accounting treatment that a company uses. This sadly means the typical chargeable event gain rules and the 5% withdrawal rules do not apply to companies.

There are two main accounting standards, namely 'Historic Cost' and 'Fair Value'.

'Historic Cost' is where the initial investment amount would show on the balance sheet at end of company's accounting period and the actual value is irrelevant. Effectively the investment is tax deferred until a disposable event occurs as there is no gain or loss at this point and thus no corporation tax issues.

'Fair Value' is where the surrender value amount would show on the balance sheet at the end of the company accounting period. Any gain is subject to corporation tax and any loss is likely to be relievable for corporation tax calculations.

Which method a company uses it where it becomes complex.

Previously small companies used the 'Historic Cost' basis and large companies the 'Fair Value' basis. This was under the old Financial Reporting Standard for Smaller Entities (FRSSE) regime so let's ignore this. FRS 102 has now replaced this for many small, medium and large sized companies which we will come to in a while.

'Micro Entities' mainly adhere to their own special rules FRS 105 which effectively means they use the 'Historic Cost' basis. Without going into too much detail these are just really small companies and under these rules no assets can be measured at a fair value.

So we come to the pain of FRS 102. This is the main new UK Generally Accepted Accounting Practice (GAAP) standard. It replaces all previous regimes and terminology and simplifies affairs to a degree (probably in the same manner A Day did for pensions!)

Under FRS 102, 'basic financial instruments' can be valued using the 'Historic Cost' basis but a typical investment bond would fall outside the definition and hence come under the 'Fair Value' basis. Any disposals are called a 'related transaction' with any gain or loss producing a non-trading credit (NTC) or non-trading debit (NTD).

For an Onshore Bond relief is obtained via the basic rate tax paid within the fund. This amounts to 25% of the profit on disposal which a company can offset against the overall corporation tax liability for the relevant accounting period. Unfortunately, if it exceeds their tax liability then the excess is not repayable and can't be set off against any other accounting periods.

For an Offshore Bond this works in a similar manner although there will be no grossing up of the profit and thus no tax treated as paid to offset against the company's corporation tax liability. For 'Micro Entities' under the 'Historic Cost' basis when a disposal occurs and a profit arises then no basic rate adjustment is required and that profit is taxable at the relevant corporation tax rates.

All nice and straightforward as usual.