10.5.Detail the issues surrounding the provision of benefits to participators and associates
Any expenses incurred by a close company in providing benefits or facilities for such things as living accommodation, entertainment, domestic and other services of any kind for a participator or an associate of a participator will be treated as a distribution made by the company (Section 436(3) TCA 1997).
Specific provisions counter two or more close companies from arranging to make payments to one another’s participators. The expense payments are deemed to be made by the respective close companies to their own participators (Section 436(7) TCA 1997).
The following expense payments are not treated as distributions:
1. Any expense made good i.e. reimbursed to the company by the participator (Section 436(3)(a) TCA 1997)
2. Any expense incurred in providing benefits or facilities to directors or employees which are already assessable as benefits in kind under Schedule E (Section 118 and Section 436(3)(b) TCA 1997)
3. Any expense incurred in connection with the provision for the spouse, children or dependent of any director or employee of any pension, annuity, lump sum or gratuity to be given on his death or retirement (Section 436(3)(b) TCA 1997).
Amount of the distribution
The amount of the distribution is determined in accordance with Section 436(3) TCA 1997 as an amount equal to so much of the expense as is not made good to the company.
Dividend withholding tax on the amount of the distribution will be determined in accordance with Section 172B(3) TCA 1997 on the basis that the distribution would be regarded as a non-cash distribution. Please refer to Chapter 6 for details on how non-cash distributions are treated.
Effect on taxable income of company and recipient
The amount of the distribution determined in accordance with Section 436(3) TCA 1997 (i.e. the expense not reimbursed by the participator to the company) is a distribution and therefore not an allowable deduction in the computation of the Case I tax adjusted profits of the company.
Where the recipient is an Irish resident individual, the distribution is treated as income received under Schedule F. The individual is liable to income tax on the total distribution (i.e. the expense amount not reimbursed and the DWT on the grossed up amount if DWT on the net amount is not paid over to the company) at his/her marginal rate of income tax (plus PRSI and USC). He/she may claim a credit for the DWT incurred against his/her own income tax liability.
Where the recipient is an Irish resident company, the distribution is treated as Franked Investment Income and is exempt from corporation tax but may be subject to the Close Company Surcharge (see section 10.10 below).
For foreign resident companies and individuals receiving the dividend certain exemptions from dividend withholding tax may apply as outlined in Chapter 8.
Generous Ltd incurred an expense of €1,500 in providing a luxurious Caribbean cruise for an Irish resident individual shareholder who is neither an employee nor a director in March 2018. The shareholder is a participator in Generous Ltd. which is a close company.
Accounts are prepared to 31.12.18.
A) Corporation Tax
1. The expense of €1,500 is disallowed and is added back in the adjusted Case I profit computation as it is treated as a distribution.
2. The company is deemed to have made a distribution and must account for dividend withholding tax. Assuming that the shareholder will not reimburse the company for the DWT liability, the expense must be grossed up to €1,875 (€1,500/80) to calculate the amount of the relevant distribution for DWT purposes.
DWT of €1,875 × 20% = €375 is payable. If the company records the DWT expense “above the line” in operating profit in its financial statements, the DWT amount must also be added back in calculating the Case I tax adjusted profits of the company.
3. The net effect of 1. & 2. above is that the company has paid €1,500 for the holiday and also €375 withholding tax. The grossing-up effectively assumes that the recipient will not pay over the DWT to the company, and has effectively treated that unrecovered DWT as part of the distribution; that is:
The original DWT in respect of the distribution would have been €300 (i.e. €1,500 × 20%). Assuming this DWT was not repaid, it would be regarded as an additional distribution giving rise to additional DWT of €60 (€300 × 20%). This unpaid additional DWT would be regarded as an additional distribution resulting in additional DWT of €12 (i.e. €60 × 20%). Reiterating this gives rise to further additional DWT of €2.40 (i.e. €12 × 20%), €0.48 (i.e. €2.40 × 20%), etc. The total of all these DWT liabilities (including the additional DWT liabilities arising on the unpaid DWT liabilities being treated as distributions) is €374.88 which is approximately equal to the €375 DWT liability determined by grossing-up.
If the participator/recipient had repaid the initial DWT in respect of the benefit, it would not be necessary to gross-up as the total benefit that would have been received would be the value of the benefit less the DWT repaid (i.e. in the example above, if the shareholder repaid the initial DWT of €300 (i.e. €1,500 × 20%) the net benefit received would have been €1,200 and the individual would not have received the benefit of the unrecovered DWT).
In effect, it would leave the individual in the exact same position as if the company had simply made a cash distribution of €1,200 after applying DWT of €300.
For the purposes of your exam, unless stated otherwise, where a non-cash distribution is made (including distributions in specie) you should assume that the initial DWT liability is not repaid such that gross-up provisions apply.
B) Income Tax
The shareholder is not assessed under Schedule E as he is not an employee or director but is treated as having received a distribution liable under Schedule F. The assessable amount is €1,875 with a credit for the related DWT of €375.
If the shareholder pays income tax at the marginal rate, then the income tax computation would be (ignoring the impact of PRSI and the USC):
The company is entitled to demand repayment from the shareholder of the tax credit but will rarely do so in practice.
If the shareholder repaid the initial DWT to the company, assuming the shareholder pays income tax at the marginal rate, the income tax computation would be (ignoring the impact of PRSI and the USC):
i.e. by repaying the initial DWT, the shareholder would reduce his income tax liability by €75 (i.e. €375 – €300) but increase the overall cost of the dividend (i.e. total cost of €600 (DWT of €300 and income tax of €300) compared with a total cost of €375 (i.e. the income tax) where the DWT is not repaid). Therefore, the shareholder is better off not repaying the DWT.
Mr. A holds 2% of the ordinary share capital of X Ltd which is a close company. Mr A is not an employee or director of X Ltd.
X Ltd. pays the rent on Mr. A’s house of €9,000 per annum, this amount is charged each year in X Ltd’s accounts under rental expenses.
What are the tax implications of the above transaction for X Ltd and Mr. A in the year ended 31st December 2018 assuming Mr. A does not repay the DWT to X Ltd.