Covid concessions for closely held companies to go but should the law be changed anyway

Tom Maguire discusses Covid concessions for closely held companies in his Business Post column

Closely held companies get special treatment in the Taxes Acts. Not in a good way. A “close company” is defined in tax law in a complex manner but the nutshell version is a company that’s controlled by five or fewer “participators” (together with their associates i.e. relatives etc.), or any number of participators (and their associates) who are directors. A participator is, broadly speaking, any person with a share or interest in the capital or income of the respective company. Therefore, close companies can comprise everything from family companies, to 'mom and pop' companies, to two college buddies incorporating a start-up and so on. Even some quoted companies get to be so regarded where the necessary terms and conditions are met.

One of the tax disadvantages of a close company is what’s known as the “close company surcharge”. That says that if a company doesn't pay out certain investment profits to its owners within 18 months then those profits will be liable to a 20% surcharge on top of its normal tax bills.

Covid19 paused that for a while where Revenue made certain temporal concessions on the surcharge not applying. They said that they would, on application, extend the 18-month period by nine months where a distribution cannot be made because of Covid19. That was done to enable the company “to be better informed in relation to the impact of its current circumstances before making a distribution”. Those profits may be needed in the company rather than in the after-tax hands of its owners.

This concession applied to accounting periods ending from 30 September 2018 onwards for which distributions to avoid surcharge would be due by 31 March 2020 onwards. At the same time, it required that records of the circumstances regarding the application to delay making a distribution must be kept. It was only to apply to accounting periods ending up to 31 March 2022. Normal close company surcharge provisions would apply to accounting periods ending after that date.

And here we are in a post 31 March 2022 world. That means that a close company with a year end after 31 March 2022 will have to consider whether it needs to pay out certain profits quicker in order to avoid the 20% surcharge.

The idea behind the close company surcharge is to ensure that the company pays out the respective profits so that the owners are liable to the higher rates of income tax on that distribution. This is in comparison to the lower rates of tax that apply to a company. But what if the company really needs that money for its own activities? What if the company wants to invest such profits in certain activities to grow its business? That doesn't matter because unless it's distributed to the owners within the 18-month deadline then the extra 20%, in addition to its "normal" corporation tax, becomes payable.

This is an anti-avoidance measure and you can see why it’s there given the tax rate disparity between company and human but it’s mechanical in approach (i.e. the clock struck 18 months so pay up). It doesn’t take into account the commercial circumstances of the company. You have to remember that these companies are already subject to anti-avoidance measures which other companies aren’t subject to.

For example, if a close company makes a loan to an owner then withholding tax is payable on that loan, albeit it can be refunded when the loan is repaid. Certain expenses paid on behalf of owners won’t be deductible in computing the company's tax bill and will be subject to income tax. Interest paid on loans to certain directors over a particular limit will be subject to income tax. A recent Finance Act brought about a provision which taxes arrangements that allowed for the exit of the owners in favour of others at the rates of income tax. In the past, such arrangements would have been taxable at the Capital Gains Tax Rate of 33% and not the higher income tax rates.

Of course, there may be instances where a tax avoidance motive is present and then it’s only right that appropriate counter measures kick in. That said, I always remember Finance Minister Richie Ryan's comment when certain Capital Gains Tax Rules were being brought about: "I fear we must, in the words of St Paul, see the innocent suffer for the guilty". Entrepreneurial companies may want that “surchargeable” cash to develop the business such that more tax may ultimately be payable by that company in the future through corporate tax on its profits, PAYE on increased employee numbers and so on.

If there is a concern that there is abuse going on, then Revenue always have the General Anti-Avoidance Rule (GAAR) to rely upon and that wasn't around in Ryan's time. Its purpose is that if all else fails then a tax advantage can be removed where it was "reasonable to consider" (that's how it's written i.e. not "beyond a reasonable doubt", etc.) that something was done primarily to achieve a tax advantage. There’s a book on the GAAR out there, but I won’t mention its author here! In addition, a reinvestment provision could be brought in to mitigate the surcharge’s application. Put another way let not the innocent suffer for the guilty.

Of course, it’s a different matter if there is tax avoidance going on and it’s right that it be countered as discussed earlier. Many stakeholders, including yours truly, will be asking for simplification of tax measures to ensure that scaling companies can have access to cash, for example, a simplification of the Employment Investment Incentive regime (a tax relief which aims to encourage individuals to provide equity-based finance to trading companies) as well as allowing loss relief on such investments. It would appear reasonable to combine such measures with an appropriate removal of the close company surcharge to allow such companies to reinvest cash within the business.

Please note this article first featured in the Business Post on 3 April 2022 and was re-published kindly with their permission on our website.

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