What are the tax implications of holding shares within a limited company?
It is probably a fair assumption to make that most people reading this article are investors, either directly or through some type of pension arrangement. One question that does crop from time to time though is whether it is worth considering holding investments within a limited company structure instead.
Well, on the face of it, there would appear to be a number of advantages. With the soon-to-be-upon-us 50% rate of income tax, high earning investors will be faced with a higher rate tax liability on dividends of 42.5%, albeit with a 10% tax credit. This does not compare favourably with the current small companies rate of corporation tax of 21%.
Companies are also charged to corporation tax on chargeable gains made, but given the recent changes to capital gains tax for individuals, even a 21% rate would be higher than the new 18% flat rate of tax for individuals. However, when the 18% rate was introduced, indexation allowance was simultaneously removed. For individuals.
Yet companies are still able to deduct indexation from any gain arising on a sale of shares, which could prove very valuable, particularly in times of high inflation. Yes, I know high inflation is a pipe dream at the moment, but remember investment is a long-term game.
So far, so good. However, before you start calling your accountant to ask why you haven't previously been advised of such an easy-peasy tax planning idea, there are three little words you need to hear first. No, not those three little words (I hardly know you after all), but Close Investment Company. Or Close Investment-Holding Company (CIC), which doesn't fit the three little words bit quite as well.
So what's a CIC?
Without being too pedantic, a close investment holding company is a close company that holds investments. As a result, in order to see whether a given company is a CIC, you need to consider whether it is close and then whether it falls within the investment holding company definition as it applies to close companies.
In broad terms, a close company is a company which is under the control of:
- five or fewer participators, or
- any number of participators if those participators are directors, or
- more than half the assets of which would be distributed to five or fewer participators, or to participators who are directors, in the event of the winding up of the company.
Clear? I thought not.
In English, a close company is one controlled or owned by a small number of people, known as participators. However, the interest of a participator in a company may be expressed as the amalgamation of his or her own personal holding, together with the holdings of people connected with that person (associates), to include spouses, parents, children, siblings and business partners.
As a result, unless any Fools reading this are feeling particularly generous and intending to set up a company with a whole load of unconnected people as shareholders (and if so, I would be happy to participate), a company established to hold investments is likely to be a close company.
If you are suffering from insomnia and would like to read the detailed rules on what does or does not constitute a close company or a participator, there is a wealth of information in the relevant HMRC Manual.
So, assuming our hypothetical company is going to be close, will it also be an investment holding company and therefore fall within the CIC rules?
It has to be said, the clue is in the name. The statutory definition of a CIC is a close company other than one whose main activity is trading commercially or investing in land for (unconnected) letting. So, in most circumstances, we will have a CIC.
Surely being a CIC is a good thing?
Being a CIC is a very good thing. For the taxman.
As described above, the small companies rate of taxation, available (broadly) on profits up to £300,000, is 21%. CICs are not allowed to pay tax at the small companies rate and will instead have to pay tax at the full main rate, currently 28% on all profits.
28% is still lower than the rate an individual faces on similar dividends, but not by so much, which means other factors like reporting requirements and accountancy fees will also have bearing on whether shareholding through a CIC is worthwhile.
Also, the rate of tax on chargeable gains will be 28% for a CIC, now a whole 10% higher than the rate for individuals, meaning the indexation allowance needs to be substantial in order to even match that lower rate.
As with any company, there is also always the potential for a double tax charge on gains -- if the company sells shares it will pay corporation tax on the gain, and if you then sell those investment-owning company shares, you may then have an additional personal capital gains tax liability. Although this can sometimes be managed through the payment of dividends to extract profits, if you are a higher, or highest rate taxpayer even this route will attract an additional income tax charge on monies that have already suffered tax.
And if that weren't enough, there are all the additional restrictions placed on all close companies, including the charge on loans to participators, the extension of the definition of distribution… need I go on?
More on tax from Sam Thewlis:
