10.12.Recommend how a company can still meet its commercial objectives while reducing the surcharge payable
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:
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:
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:
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.
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.
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.
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%).
Mr. J Jones associates are as follows:
As Mr. J Jones possesses 56% of the voting power, the company is close.
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.
For a quoted company not to be treated as close, it must satisfy all of the above conditions.
(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:
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:
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.
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.
The limit of interest which is allowed is the lower of:
∴ the limit of interest allowed is €1,300
Interest paid to the director in 2018 = €4,000
∴ excess treated as a distribution = €2,700
1. A Ltd disposes of the property to Mr. A at market value
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:
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.
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:
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
Frank Director Account
Dermot Director Account