This is a question that I am often asked by clients seeking higher returns on their cash than they would otherwise achieve from a bank, where they do not want to extract the cash from the company due to the tax that would be suffered on dividends, or believe that the investment would be taxable deduction in their accounts.
In general I try to steer clients away from holding investments in a trading company, for reasons around the isolation of risk and also tax – this means either holding them personally (after having paid tax on dividends drawn) or via a separate company specifically set up to hold investments (with cash lent from the trading company to the investment company). Each case is different however in terms of asset class (stocks, property, precious metals, currency etc), time horizon and attitude to risk; though the below principles apply pretty much across the board.
In terms of the isolation of risk, if financial assets (including investments) are held in a trading company and some form of claim is made against the trading company (such as IR35, case in point being the Christa Ackroyd case last year) then you could be forced to sell the asset in order to settle the claim, though the risk here is no more so than if the asset was cash.
In terms of the tax treatment, the below is based on current tax legislation, which is clearly subject to change, especially over the medium/long time horizon:
1. The initial investment is not treated as a trading expense, and would therefore not benefit from Corporation Tax relief in the same way as an expense – for accounting purposes it will sit as an investment (asset) on the company’s balance sheet until such a time as it is sold.
2. On the eventual disposal of the investment/asset, you will pay corporation tax on any gains (i.e. the sale proceeds less the initial investment). However, unlike individuals, companies do not have an annual exemption for capital gains and can no longer claim indexation allowance on any gains (this changed only last year). Further, if on disposal of the asset, a loss is made, this cannot be set against your company trading income but must be set against other gains from the same activity (i.e. stocks/rental etc). If you have not utilised any capital tax losses (i.e. set them against other gains) before the company is closed, they do not transfer to you personally.
3. If the asset generates an income (i.e. rent), the company will pay tax on the income, and you will also pay tax to then extract the income from the company, though dividends received by companies are not subject to any further tax on the company side.
4. Holding investments in your trading company could affect your entitlement to entrepreneurs relief (assuming it is still around) come the time that you wish to close your company – this risk of this is minimal as you would need to have a high portion of the company’s financial resources (including your time in managing a portfolio) tied up in the investments for this to happen. Likewise, if you wanted to liquidate the company at any point then you would need to transfer assets (including investments) out of it in the process, causing a tax event at that point also.
Let’s say you have £10k to invest for 10 years and hope to achieve growth of 8% per annum (compounded over the period) and the decision between investing the funds via your limited company or personally is entirely tax motivated. It is assumed that any additional income taken from the company now would suffer higher rate tax, and that the same is forecast for when you plan to exit the investment in 10 years’ time. It is also assumed that all tax rates/allowances remain the same (an unlikely assumption).
If the company invests £10k, there’s no tax relief on the initial investment and so the amount invested is £10k. You hold onto this for 10 years, achieving compound growth of 8%, as planned, and sell the shares for £21,589 (10,000 x 1.08^10). Now the company has a chargeable gain of £11,589 (£21,589 proceeds less £10,000 cost) which will be taxed at 19%, increasing your corporation tax liability in that year by £2,201 and leaving the company with £19,388 from the investment proceeds. Next, you need to get these profits out of the limited company, so pay a dividend for the full amount after having paid corporation tax (£19,388) and are taxed at 32.5% on it (£6,301). This leaves you with just £13,087 in your pocket.
On the other hand, if your limited company paid a dividend of £10k now, and you invested the post-tax distribution – you would have £6,750 to invest after 32.5% dividend tax (sounds bad but keep reading!). You invest the £6,750 in the same stock as you would have done from the company, apply the same growth in the same way (6750 x 1.08^10) and you sell it in 10 years’ time for £14,572. Gains on personally held investments are subject to capital gains tax on any profits (proceeds less cost) in excess of the annual exemption (£12,000) at 10% for basic rate taxpayers or 20% for higher rate taxpayers (with an 8% premium if the asset is residential property). The gain in this case is £7,822, and therefore below the annual exemption and so no additional tax would be due, meaning that the taxpayer is better off by £1,485 by investing the money personally vs through the limited company.
Finally, the same investment made within a pension wrapper: given pension contributions for a director are a trading expense for tax purposes, a contribution of £12,345 will cost the company £10k (after corporation tax relief at 19%) – so £12,345 is the amount invested from the pension pot. 10 years growth at 8% makes this worth £26,651 at the end of the same time horizon as the other examples. Assuming this is the only money in the pension pot, when the pension is then drawn a lump sum of 25% at retirement is tax free (£6,662), with the remainder drawn as income in retirement (for balance, I’ll assume higher rate for this portion of your income) on which you will pay tax of £7,995 in total. The net effect of the increased investment, and 25% tax-free lump sum leaves you with £18,656 in your pocket after tax, albeit spread over your retirement.
My suggestion is therefore that, unless you need access to the cash in in the short/medium term (in which case it’s debatable whether either property or shares would be a good idea, though investment advice should be sought from a suitably qualified professional) – then you could invest surplus cash via a pension. This way you get corporation tax relief on the investment into the pension (subject to a couple of conditions) and there is no tax on income or gains held within that investment wrapper. Clearly there is a risk with pensions, in that tax rules could feasibly change between the investment in the pension and the drawing of it, again, particularly if you are looking over a longer time-horizon.
Clearly this is an example to highlight how this works and doesn’t include dividends/fees/your actual tax situation – each of which could change the outcome.