Business Taxes

10.12.Recommend how a company can still meet its commercial objectives while reducing the surcharge payable

Example 10.18

This example takes the same facts as Example 10.16 (B Ltd).

The company wishes to avoid the surcharge entirely and request details of the minimum dividend they can declare and pay and by the latest date possible.

B Ltd (a service company) has the following results for the accounting period ended 31 December 2018:

Chargeable gain (as adjusted) 5,000
Trading income (professional) 32,000
Rental income 6,000
Bank interest (Gross) 8,000
FII (Gross) 2,000

B Ltd paid charges of €3,000 in respect of its trading activities and claimed €4,000 of loss relief under Section 396(1) TCA 1997 for a loss which arose in AP ended 31.12.17. The company made distributions of €2,000 in the year ended 31 December 2018 and paid expenses of €400 for a participator (for the purposes of this example, assume the participator did not repay the initial DWT such that gross-up applies).

1. The distributable trading income of the company is calculated as follows:

Case II 32,000
Less relevant trade charges (3,000)
29,000
CT @ 12.5% (3,625)
Distributable Trading Income 25,375

2. To calculate half of the distributable trading income, i.e. €25,375 divided by 2 = €12,687.

3. Add to amount at point 2 the distributable investment and estate income (net of trading discounts.

Distributable Estate and Investment Income:

Schedule D Case II 32,000
Case III 8,000
Case V 6,000
46,000
Less: Relevant trading charges (3,000)
43,000
13,087
Franked Investment Income 2,000
Estate and Investment Income 15,087
Less: Corporation tax (€13,087 × 25%) (3,272)
11,815
Less: Trading discount @ 7.5% (886)
Distributable estate and investment income 10,929
Half of distributable trading income 12,687
23,616

4. Less distributions made

(2,500)
(€2,000 + €500 (€400/80%))
Distribution to avoid surcharge (19,116)
Total surchargeable amount 2,000
5. Excess of distributable estate and investment income over distributions made
Distributable estate and investment income 10,929
Less: Distributions made (2,500)
(19,116)
Surchargeable 0

6. Surcharge at 20% on €0 = €0

7. Surcharge at 15%

Total surchargeable amount 2,000
Less: Excess levied at 20% (0)
Total 2,000

Surcharge at 15% = €0

As the surchargeable amount is €2,000 there is no liability (Section 441(4)(b) TCA 1997)

The distribution must be paid on or before 30 June 2020, 18 months after the period end.

Note:

For the purposes of the exam unless otherwise stated, assume the participator did not repay the initial DWT arising in respect of the expenses incurred by the company on behalf of the participator such that the gross-up provisions apply.

One other option would be declare directors’ fees to reduce both the taxable trade income and therefore the income surchargeable. However, as only 50% of the service income is surcharged the fees would need to be much higher than the dividend.

There is also the possibility that the fees might not be allowable against corporation tax if it were felt that they were not wholly and exclusively incurred in running the business.

Key Point

Close company rules are designed to prevent shareholders in family companies from extracting funds from their companies without paying income tax at the marginal rate.

Key Point

The 20% and 15% surcharges are imposed to narrow the gap between the tax the company pays on its profits (12.5% or 25%) to what the shareholder would pay if he or she earned the profits personally (c. 25% – 55%).

Task Answers

Task 10.3

Mr. J Jones associates are as follows:

Mrs. Jones (his wife) 13,000
Mr. P Jones (his brother) 3,000
Trustees of settlement by Mr. J Jones 5,000
21,000
The rights and powers attributable to Mr. J Jones are:

1. The rights and powers of his associates

21,000

2. The rights and powers of Gamma Ltd

10,000
31,000
Plus: His own rights and powers 25,000
56,000

As Mr. J Jones possesses 56% of the voting power, the company is close.

Note

The rights of an associate of an associate of Mr. J. Jones cannot be attributed to him i.e. Beta Ltd.

The rights of ‘in laws’ cannot be attributed to Mr. J Jones as an ‘in law’ is not a relative.

Task 10.4

Delta Gamma

1. Is the company under control of 5 or fewer participators

Yes Yes

2. Are shares carrying not less than 35% of voting

rights held by “public” Yes No
Superannuation fund 20 20
Individuals 20 10
40% 30%

3. Do the Principal members control < 85% of

voting power Yes No
Close Company 1 40 40
Close Company 2 20 30
Superannuation Fund 20 20
80% 90%
Status OPEN CLOSE

For a quoted company not to be treated as close, it must satisfy all of the above conditions.

Task 10.5

(A) Corporation Tax

1. The rental expense of €9,000 is disallowed to X Ltd in arriving at its profits assessable to corporation tax as it is treated as a distribution of €11,250 (€9,000/80%) (X Ltd is a close company and Mr A is a participator)

2. X Ltd. has a dividend withholding tax liability of €11,250 × 20% = €2,250.

(B) Income Tax

Mr. A will be assessed under Schedule F on the distribution. If Mr A pays income tax at the marginal rate, then the income tax computation would be:

Schedule F 11,250
Income Tax payable @ 40% 4,500
Less: Dividend withholding tax (2,250)
∴ Additional income tax payable by Mr. A 2,250

If Mr. A repaid the initial DWT liability the value of the distribution would be €9,000. This amount would be disallowed by X Ltd. in determining its tax adjusted Case I profits and would be taken into account for the purposes of determining the company’s close company surcharge for the period (if any).

Mr. A would be assessed under Schedule F on the distribution. If Mr A pays income tax at the marginal rate, then the income tax computation would be:

Schedule F 9,000
Income Tax payable @ 40% 3,600
Less: Dividend withholding tax (1,800)
∴ Additional income tax payable by Mr. A 1,800

i.e. by repaying the initial DWT, Mr. A would reduce his income tax liability by €450 (i.e. €2,250 – €1,800) but increase the overall cost of the dividend (i.e. total cost of €3,600 (DWT of €1,800 and income tax of €1,800) compared with a total cost of €2,250 (i.e. the income tax) where the DWT is not repaid). Therefore, the shareholder is better off not repaying the DWT.

Task 10.6

If Apple Ltd was not close the entire interest charge of €9,000 would be allowable against the company’s income.

The company would deduct tax of €1,800 from the gross interest prior to paying the relevant amounts to Mr A, Mr B and Mr C. Each director would suffer tax under Schedule D Case IV with a tax credit for the tax withheld.

Under Section 239 TCA 1997 the company would include the €1,800 as a liability in its corporation tax return.

Task 10.7

The limit of interest which is allowed is the lower of:

13% of €10,000 = 1,300
13% of €40,000 = 5,200

∴ the limit of interest allowed is €1,300

Interest paid to the director in 2018 = €4,000

∴ excess treated as a distribution = €2,700

Task 10.8

1. A Ltd disposes of the property to Mr. A at market value

Sales proceeds 150,000
Cost (75,000)
Capital Gain 75,000

Regross: €75,000 × 33%/12.50% = €198,000 × 12.50% = €24,750

2. Mr. A has paid full market value and therefore there is no distribution.

3. Sale of Mr. A’s shares:

Sales proceeds 175,000
Cost (125,000)
Capital Gain 50,000

By paying the full market value Mr A avoided income tax on the distribution of €20,000 (ignoring PRSI and the USC) and saved €16,500 in CGT (i.e. by avoiding the reduction in base cost of €50,000 × 33%) – a total of €36,500 in taxes. It also resulted in the company paying corporation tax on the chargeable gain based on income it actually received, rather than notional income.

Task 10.9

R Ltd will be required to pay income tax in respect of the loans to Mr. Ben and Mr. Alan grossed up at the standard rate of 20% as if the grossed up amount were an annual payment. The tax penalty for the company is calculated as follows:

Mr. Ben 14,200
Mr. Alan 8,000
€22,200 × 20/80 = €5,550

The loan to Mr. Carl is not caught because Mr. Carl:

Is a director

Does not have a ‘material interest’ in the company

The loan is less than €19,050

R. Ltd must pay the income tax of €5,550 to the Collector General.

Answer to question in Example 10.9

Aidan Director Account

Balance b/f 2017 500 Remuneration 10,000
Payments 6,000 Prometheus Services 5,500
Balance c/f 2018 14,000 Short term loan 5,000
20,500 20,500
  Balance b/f 2018 14,000

Frank Director Account

Balance b/f 2017 5,000 Remuneration 25,000
Payments 18,000
Balance c/f 2018 2,000
25,000 25,000
  Balance b/f 2018 2,000

Dermot Director Account

Repayment Car loan 10,000 Balance b/f 2017 2,000
Payments 25,000 Remuneration 25,000
Balance c/f 2,000 Car loan (short term) 10,000
37,000 Total 37,000
  Balance b/f 2018 2,000