Welcome to the May edition of our Financial Services newsletter.

In this edition we ignore the obvious issues in financial services surrounding the election and crisis in financial markets and concentrate on more practical areas. Please click on the links below to read each article.

Capital Allowances and Your SSAS – Borrowing with Extra Tax Relief
In the current climate when bank lending is hard to come by and expensive when available, alternatives are always welcome and, if they come with tax incentives, then all the better. Read on for an interesting way of combining investment and pension tax reliefs for companies.

EFRBS
Another wonderful acronym – this time it’s Employer Funded Retirement Benefit Schemes –gives high earners an opportunity to extract funds from a company with some tax breaks. This could be a welcome respite from the 50% tax rate and removal of higher rate tax relief for those earning more than £150,000.

Business Protection
All too often ignored by directors, partners and shareholders, business protection insurance is designed to protect against the worst and should be looked at very carefully even when finances are tight.

Save and Spend – have it Both Ways

The ability of Small Self Administered Schemes (SSAS) to provide loans to the sponsoring employer has, since April 2006, probably been the main reason to use this sort of arrangement rather than the simpler and cheaper Self Invested Personal Pension (SIPP).

The rules on SSAS loans to companies can be fairly complex but the main features are that they can be no more than 50% of the scheme assets, have to secured as a first charge on non-depreciating assets, have a term of no more than five years and be repayable as capital and interest. The interest rate must also be in line with market rates or fixed in relation to bank base rates.

When used correctly, this facility can be a powerful way of using assets that are otherwise tied up to boost business finances in a time when borrowing is difficult to come by and pay yourself interest rather than the bank.

However, there is an additional tweak which can make the use of pension contributions and loanbacks to the company even more tax efficient. This uses the company’s annual investment allowance.

This is nothing to do with pensions as it relates to business expenditure relief. It currently gives 100% tax relief on up to £100,000 of business expenditure on some forms of plant and machinery.”

Let’s say, for ease of argument, the company had gross profits of £100,000 and pays corporation tax at the smaller companies rate of 21%. It was considering purchasing machinery worth £40,000. So if it had purchased the machinery out of company money, the £40,000 cost would be fully relievable under the annual investment allowance and thus would bring the company’s taxable profit down to £60,000 giving rise to corporation tax of £12,600

The alternative approach, rather than spend £40,000 on machinery, is to spend the £40,000 as a contribution into the SSAS and, assuming that the SSAS already had assets of more than £40,000 already in place, then it could loan back up to 50% of its new gross value to the pension fund or £40,000. Effectively, this is a circular transaction.

The pension contribution is fully tax relievable and so is the £40,000 that has been spent on machinery because it qualifies under the annual investment allowance. So the gross profit of £100,000 is reduced by the £40,000 pension contribution and by a further £40,000 for the relievable purchase of machinery, bringing the taxable profit down to £20,000 and thus the corporation tax bill down from £12,600 to £4,200 – a tax saving of £8,400.

So, in this scenario not only does the company get the machinery, there will be an extra £40,000 in its pension scheme and it saves £8,400 in tax.

Of course there could well be some charges to arrange the SSAS loan, which does require a first charge security, and they do now need to service the loan from the SSAS, making repayments over five years. If we assume that the loan interest is fixed at, say 3%, for five years, then the total interest paid will be £3,224.51 – substantially less than the tax saved in the first year – and, of course, the interest simply serves to increase the value of the pension fund.

The strategy clearly works well for limited companies who can form a SSAS but it can also be extended to LLPs with a some extra work.

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EFRBS
Overuse of acronyms is a perennial criticism of the financial services industry and the EFRBS (Employer Funded Retirement Benefit Schemes) are the replacement for FURBS and UURBS removed by the pension legislation of April 2006. They are HMRC approved pension schemes; but unlike normal pension schemes there are no investment restrictions – that means residential property is allowed – and there are no restrictions on contributions or overall fund value.

However, the downside for the employer is that the contribution to the EFRBS will only be deductible for corporation tax as and when benefits are paid to the member and, of course, these benefits are fully taxable in the hands of the member at their tax rate at the time.

However, there is no immediate tax charge for the member on the contribution to the EFRBS and, as the contribution is not treated as a benefit-in-kind, there is no national insurance charge.

The main advantage of the EFRBS for the member is the ability to get a largely tax free investment vehicle if the EFRBS is set up appropriately using offshore vehicles with a larger investment lump sum than if paid by salary or dividend. This allows an investment fund to be managed in the long term with gains and interest rolled up gross of tax. Unrestricted investments means that loans can be made back to the company and residential property can be purchased.

When benefits are drawn at or around retirement they will be subject to income tax but there may be means of managing this liability at the time. Loans can also be drawn from the fund thereby avoiding the immediate income tax charge – although, of course, the company will not receive the corporation tax deduction until taxable benefits are drawn.

In addition, recent clarification of the inheritance tax (IHT) treatment means that all funds placed within the EFRBS will be IHT-exempt as long as the trust deed for the scheme is correctly drafted and excludes members from receiving ‘non-retirement’ benefits (such as non-commercial loans) or retirement benefits before age 55.

While not a panacea for high earners, EFRBS offer an alternative to highly taxed salaries and dividends now that conventional pension contributions are restricted for tax relief purposes.

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Keyman, Loan and Shareholder Protection

There are three key areas of protection in a business: loan protection in the event of the death of a key member of the business, protecting turnover and profit in the event of that same death and succession planning for the shareholders/partners.

Debt protection is, rather surprisingly, often overlooked. Despite forming part of most loan agreements with the bank, it is remarkable the number of business where this has been put to one side and never actually completed. This can be for medical reasons, time constraints or due to cost. In many cases, the bank doesn’t check to see if the insurance is in place and the issue goes unnoticed.

However, given that the insurance will have formed part of the loan agreement, not having it in place can be a breach of those terms and, of course, should a death occur the bank’s first priority will be ensuring that its funds are secure rather than moving the business forward.

A common complaint on this insurance is the sky high cost; it is important to look carefully at the cover actually needed and the commission that whoever is arranging the insurance is receiving. Banks are particularly guilty of placing business with the maximum commission without looking at the reductions in premiums that can be achieved by reducing the commission. A fee based adviser can do this and should always be considered for life assurance.

Keyman assurance is relatively simple and can be viewed as an extension of debt protection. The business insures a key member of staff for any financial loss should they die. The death benefit is used by the firm to cushion the financial impact of the key person’s death on the business and can be used to cover temporary replacement costs, recruitment fees and other costs.

Succession planning is more complicated but no less important. Far too many businesses don’t have a business will which sets out what will happen to the business on the owner’s death; without this and a clear plan for moving the business forward, the loss of the owner can quickly turn into the end for the company.

Surviving business partners could find themselves with the spouse of their former partner as their new business partner which may not be helpful for business. Furthermore a surviving spouse who does not want to run a business that has been forced upon them, and is subsequently in a hurry to sell that business, is likely to get much less than one who is not. The lack of direction after a death can cause fear within staff and customers, and competitors can soon seize that opportunity to move in.

Owners or shareholders should set up the correct business protection so that the surviving partners/shareholders can buy out the deceased's shares. This should also be set up with the correct legal agreement such as a double/cross option agreement that allows either party to buy or sell the shares in the event of a death – this is crucial for retaining inheritance tax relief.

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Contact theWealth Management Team