10.1.Explain the reason behind close company rules
The close company provisions are comprehensive anti-avoidance provisions with the aim of preventing participators (as defined) from extracting funds from a close company (as defined) in a way that avoids or reduces potential tax liabilities.
Without close company legislation, the following could happen:
Mr. A earned €100,000 income in 2018 – he paid tax on this of €40,000 (ignoring the USC and PRSI) and received cash of €60,000.
If Mr A had
1. Set up A Ltd in 2018
2. A Ltd earned the income and paid €12,500 in tax
3. Mr. A took an interest free loan from A Ltd out of the after-tax trade income and received €87,500 (€100,000 less tax at 12.5%).
4. Mr A would have received €27,500 more in cash through A Ltd than as a sole-trader.
This example ignores the potential company law implications of loans to directors (see below) and also the BIK implications of an interest free loan.
It was the above type of scenario that the close company legislation sought to prevent.
Now that the gap between income tax (40% income tax, plus PRSI, and the USC) and corporation tax (12.5% or 25%) is wider than it ever has been, a greater focus can be expected on the anti-avoidance aspects of the legislation.
10.1.1.Company law restrictions on transactions between a company and its directors
Before we explore the tax implications of close company status in more detail, throughout the remaining sections of this chapter, it is important that you remind yourself of the company law restrictions on transactions between a company and its directors which are dealt with in detail in the Law manual.
These company law restrictions apply regardless of the provisions outlined in this chapter and any breach of the company law restrictions is of course illegal and may carry criminal and/or civil penalties for the company directors involved.
The company law restrictions should always be in the back of your mind when considering the relationship between a company and its directors.