Corporation Tax (CT): Close Companies and Close Company Consequences Flashcards
What are ‘close’ companies?
Most Irish private companies are considered ‘close’ companies.
Nearly all quoted (publicly listed) companies are NOT considered ‘close’ companies.
A ‘close’ company is one that is under the control of five or fewer participators or under the control of participators who are directors, making it subject to specific anti-avoidance tax legislation.
How do ‘close’ companies relate to tax?
This anti-avoidance legislation makes it difficult for close companies to minimize their tax liabilities through various means, as it aims to prevent tax evasion and ensure proper tax compliance.
What is the definition of a close company?
Company resident in the State and:
1. Under the control of 5 or fewer Participators OR
2. Under the control of Participators (any number) who are directors OR
3. Structured so that on a full distribution of income, more than half of the income would be paid to five or fewer Participators or Participators who are directors
What is a participator in a close company?
A participator is generally a shareholder, but the definition is broad.
A participator is deemed to control the shares held by their ‘associates’
What are some of the wide definitions of a participator in a close company? (6)
- A person entitled to acquire shares in the company
- A person advancing money to a company to acquire a capital asset
- A loan creditor, e.g., debenture holder (ordinary trade creditors not included)
- A person with a right or entitled to a right to share in company distributions
- A person entitled to ensure that company income/assets in the future will be applied for their benefit
- Not a normal bank
What defines control in a close company?
Exercises, is able to exercise, or is entitled to acquire control directly or indirectly of more than 50% of the company’s:
- Issued share capital
- Voting share capital
- Income if it were distributed
- Assets on a winding up
Includes any rights/powers held by associates
Who is considered an ‘Associate of a Participator’? (4 relationships)
- Relatives
- Business partner
- Trustee of a settlement established by the participator or a relative
- Shares held by a company with which the participator and their associates are connected
Note: When counting the shareholding of a participator, include that of the participator’s associates.
Who are considered ‘Relatives’ of a Participator? (7)
- Spouse
- Civil partner
- Separated spouse
- Ancestor
- Lineal descendant
- Brother
- Sister
Who are considered ‘Relatives’ of a Participator? (3)
- Cousins
- Uncles
- Aunts
Who is considered a ‘Director’ under close company regulations?
- Any person who occupies the position of director regardless of job title OR
- Any person whose directions or instructions the directors are accustomed to act on OR
- Any person who is a manager or concerned in the company’s management AND owns or controls 20% or more of the OSC, either directly, indirectly, or through associates
Note: Individual does not have to have the title of ‘director’
What are 5 disadvantages (consequences) for close companies?
- Certain expenses for participators and their associates
- Interest paid to directors and their associates
- Loans to participators and their associates
- Write-off of loans to participators
- Close company surcharge
What are the tax consequences of distributions (dividends) for a company?
The purpose of the surcharge is to discourage the retention of profits within companies controlled by a small number of shareholders and to encourage the distribution of profits as dividends.
- Not tax deductible: Dividends paid are not deductible from the company’s taxable income, so they do not reduce the corporation tax liability (add back if in I/S)
- DWT 25%: The company must withhold 25% tax on dividends before paying shareholders and remit this to the tax authorities.
- Reduces the close company surcharge (if relevant): Paying dividends reduces retained earnings, which can lower the surcharge on undistributed investment and estate income for close companies.
What are the tax consequences of distributions (dividends) for an individual?
- Assess Schedule F at marginal rate: Dividends are taxed under Schedule F at the individual’s marginal tax rate, which can be as high as 55% including Income Tax, USC, and PRSI.
- DWT credit: Individuals receive a credit for the 25% DWT already deducted by the company, which can be used to reduce their overall tax liability.
What are the tax implications of certain expenses for participators and their associates?
Any expenses in providing benefits or facilities of any kind for a participator (or associate) are treated as a distribution.
Example:
Suppose ABC Ltd. is a private company with several shareholders, including Mr. X who owns a significant portion of the shares. ABC Ltd. decides to pay for a luxury holiday for Mr. X and his family.
• Situation: The holiday is not related to Mr. X’s duties as a director or employee. It’s purely a personal benefit. • Accounting Treatment: The cost of the holiday, say €5,000, cannot be recorded as a deductible business expense by ABC Ltd. Instead, it is treated as a distribution. • Tax Implications: This €5,000 will be added to Mr. X’s dividend income for the year and taxed accordingly under the personal income tax rates applicable to dividends. For ABC Ltd., this expense will not reduce its taxable profits because it’s treated as a distribution rather than a business expense.
What are the complications with DWT in relation to certain expenses for participators and their associates? (4 points)
- DWT can be recovered by the company from the participator
- DWT is a cost to the participator, not the company
- If DWT is not repaid to the company, it becomes a cost to the company
- Benefit is grossed up at 25% if DWT is not repaid to the company
What are the exceptions to the rule for certain expenses treated as distributions? (3 exceptions)
The following expenses are NOT treated as distributions:
If the expense is
1. Repaid to the company by the participator
2. Taxable as BIK under Schedule E
3. Connected with death or retirement benefits
What happens when directors or their associates loan money to the company and interest is paid?
Interest paid to directors or their associates is normally a deductible expense if the money is used for the trade.
Company: The company withholds Income Tax (IT) at 20% on interest paid (Withholding tax). IT is paid to Revenue by adding it to the CT due.
Individual: The individual is taxed under Case IV with credit for IT deducted.
Scenario Setup:
Let’s say there’s a company, Widget Inc., which borrows €50,000 from one of its directors, Mr. Smith, to purchase new equipment for manufacturing. The agreed interest rate on the loan is 5% per annum.
Corporate Side - Widget Inc.:
1. Interest Payment Calculation: • Annual interest paid by Widget Inc. to Mr. Smith = 5% of €50,000 = €2,500. 2. Withholding Tax on Interest: • Widget Inc. must withhold 20% income tax on the interest payment as per tax regulations. • Withholding Tax = 20% of €2,500 = €500. 3. Tax Deductibility and Payment: • Widget Inc. pays Mr. Smith the net interest after withholding tax: €2,500 - €500 = €2,000. • The €500 withheld is paid to the Revenue (Irish tax authority) by Widget Inc. This amount can be added to its Corporate Tax (CT) due or settled separately as part of its tax obligations. • The full €2,500 interest expense is deductible from Widget Inc.’s taxable income, assuming the borrowing is wholly and exclusively for business purposes (used for the trade).
What is the tax treatment of interest paid to directors and their associates with a material interest?
Interest paid to directors/associates who own more than 5% of the share capital (directors with a “material interest”) is NOT fully tax-deductible for the company.
What happens if the interest paid to directors and their associates exceeds the company expense limit?
The excess over the limit is treated as a distribution.
How is the limit for the amount of company expense on interest paid to directors and their associates determined?
The limit is the lower of:
1. 13% of all such loans.
2. 13% of the nominal value of share capital plus any share premium at the start of the accounting period.
The nominal value of share capital, also known as the par value of a share, refers to the minimum price at which shares can initially be sold by a company.
What are the two components of interest paid to directors and their associates that the company needs to apportion?
Apportion the interest into 2 components:
- Deductible amount: Withhold 20% Income Tax – add IT to CT due.
- Balance is treated as a distribution:
- Add back AND calculate and pay DWT.
- Reduce surcharge if relevant.
What are the implications for an individual receiving interest from the company?
- Interest Element (amount deductible by the company):
- Tax gross amount as Case IV.
- Credit for income tax deducted. - Distribution (amount in excess of limit - added back):
- Tax gross amount Schedule F.
- Credit for DWT.
Individual Side - Mr. Smith:
1. Taxation of Interest Income: • Mr. Smith receives €2,000 net of withholding tax but must declare the total €2,500 as interest income on his personal tax return. 2. Case IV Tax Treatment: • Interest income is taxable under Case IV (income not from employment income or trade). This involves taxing the interest received at Mr. Smith’s applicable personal income tax rate. 3. Tax Credit: • Mr. Smith can claim a tax credit for the €500 of Income Tax that was already withheld and paid to the Revenue by Widget Inc. This means he won’t be taxed twice on that portion of his income.
Tax Filing for Mr. Smith:
• When filing his personal income tax return, Mr. Smith reports €2,500 as interest income. • He calculates his tax liability based on his total income, which includes this interest. • The tax credit of €500 is applied against his total tax liability. If his personal tax rate is, for example, 40%, the tax due on the interest income would be 40% of €2,500 = €1,000. After applying the €500 tax credit, Mr. Smith would owe an additional €500 in taxes on this interest income.
What is important to note about the limit on loans to directors and their associates?
The limit applies to the total of loans to ALL directors/associates who have a ‘material interest’.
Loan amounts can vary during the accounting period – take the average loan amount for the accounting period.
