Question: A Client and his wife are directors and 50/50 shareholders in two individual limited
companies‐both trading as supermarkets. Co. 1 has Turnover of €3m and Profit after Tax of €35K. Co.
1 has Turnover of €3.7m and Profit after tax of €118K. The client has an interest in classic cars and is
thinking of setting up another company that would purchase in classic cars with the purpose of
maintaining, restoring them in a unit that they (existing companies) already rent and then selling them
on at a profit. The client would like to use some of the funds in the other two existing companies to
get this new business off the ground and is wondering about most tax efficient way to do this?
Answer:
Section 239 of Companies Act 2014 specifically prohibits loans, quasi-loans, guarantees or credit transactions to be entered into for the benefit of that company’s directors and their connected persons. Directors, for the purpose of this section includes shadow directors and de facto directors. The definition of connected persons, shadow directors and de facto directors has been considered below.
There are exceptions to the prohibition in Section 239 of Companies Act 2014 and these exceptions are where:
- the value of the loan/guarantee/credit transaction provided is less than 10 per cent of the company’s net assets as per the financial statements laid before the shareholders at the last Annual General Meeting of the company (Section 240 of Companies Act 2014).
If this exception is availed of, there is still a risk that the directors/de facto directors and shadow directors could be held personally liable for the funds loaned. This applies where the paying company is subsequently wound up due to it being unable to pay its debts and subsequently a liquidator proves to the court that the provision of the loan contributed to the inability of the company to pay its debts; – IS THIS POSSIBILITY AVAILABLE TO YOUR CLIENT FOR THE TWO COMPANIES PROVIDING THE LOAN: or
- the balance has arisen from the company entering into transactions in the normal course of business:
- and the value of the transactions is not greater than what is normally offered to other unconnected parties; and
- was not unreasonable to be offered based on the financial standing of a similar company (Section 245 Companies Act 2014)
This exception mainly applies where there is a sale/recharge of goods or services by the company to a director/de facto/shadow director and/or its connected persons as part of that companies normal trading activities. However, in cases where a loan (as opposed to providing goods/services) is provided by a company and the company providing the loan is not itself in the business of providing loans then this exception will not apply.
- the transaction/loan is between group companies where a parent and subsidiary relationship exists as defined in Section 7 of Companies Act 2014 (Section 243 Companies Act 2014); – THIS GET OUT IS NOT AVAILABLE FOR YOUR CLIENT AS IT WOULD NOT BE IN THE COURSE OF THE BUSINESS FOR EITHER OF THE COMPANIES
- the balances arise due to an advance on Director’s expenses to be incurred in the normal course of business (Section 244 Companies Act 2014); NOT APPLICABLE IN THIS CASE
- the company applies the Summary Approval Procedure requirements stated in Section 202 and 203 to permit such loans, guarantees or credit transactions. (Section 242 Companies Act 2014).
- Enter into a group under Company law as defined in Section 7 of CA 2014.
Connected persons
For the purposes of Section 239 Companies Act (prohibition of loans/guarantees/credit transactions for the benefit of the director and connected persons) a connected person is defined in Section 220 of the Companies Act 2014 as a person that is connected to a director in the following ways: –
– a director’s spouse, civil partner, parent, brother, sister or child;
– a person acting in his or her capacity as the trustee of any trust, the principal beneficiaries of which are:
– that director,
– the spouse (or civil partner); or
– any children of that director;
– any body corporate which that director or his/her connected persons controls (control being defined as owning 50 per cent or more of the equity share capital or being entitled to exercise or control the exercise of the voting power whether directly or indirectly or through a connected person whether control is exercised or not) – APPLICABLE IN THIS CASE AS THE PERSON WILL OWN THE NEW COMPANY
When assessing whether the director can control the exercise of one half of the voting power one would assess whether:
- the director/de facto/shadow director or his connected persons when taken together (including companies that the any of the aforementioned controls) own 50% or more of the voting shares;
- any of the aforementioned have the option to purchase 50% or more of the voting shares/equity share capital or the option to purchase shares such that they could get to the 50%;
- the director/de facto/shadow director or his connected persons has entered into a written agreement with another shareholder such that they will vote in line with the wishes of any of the aforementioned;
- shares are held in bare trust by an unconnected party on behalf of any of the aforementioned.
– a person who is in partnership with that director.
Shadow and de facto directors
Section 221 of Companies Act 2014 defines a shadow director (who are individuals) as a person whose directions or instructions the directors are accustomed to act.
Section 222 of Companies Act 2014 defines a de facto director as a person who carried out the duties of a director although not formally appointed.
Therefore, where a person is acting as a de facto or shadow director that person comes within the remit of Section 239 of Companies Act 2014 and the prohibitions that come with it.
Possible solutions to legally permit funds to be transferred to a connected company
There are two options available when trying to transfer funds from one company to another connected company where the prohibitions under Section 239 of Companies Act 2014 apply:
(For the purposes of the below analysis Company A is the company that provides the funds and Company B is the company that receives the funds)
1) Subscribe for preference shares in the company that is due to receive the funds
Company law analysis
When a company provides funds and in return is allotted shares in the company and both companies have common directors/shadow/de facto directors and the company is connected within the meaning of Section 220 of the Companies Act 2014 as detailed above, these do not come within the prohibitions of Section 239 of Companies Act 2014 as they are not loans instead this is an investment in the share capital of the company.
Sample rights that could be attached to these preference shares would include:
– A mandatory market rate dividend payable annually (possibly 5%);
– No right to vote;
– Right to a return of capital equal to the amount of the funds subscribed for the shares;
– Shares redeemable at the option of the company that allotted the shares or at the option of the company.
Each time a dividend is paid, a directors minute must be maintained to authorise the payment of the dividend subject to the restrictions detailed below.
Note it is possible to adjust the rights on the preference shares such that a dividend is payable at the option of the company as opposed to mandatorily payable. That said one may question why a company would make such an investment without getting anything in return.
Repayment options – restrictions under company law
Preference shares or shares of any kind allotted by a company is deemed to be part of the capital of the company under Company Law. There are significant restrictions on the reduction of a company’s capital.
With this in mind, in order for the preference shares to be redeemed in the future (and for Company A to get back its initial investment) the company that received the loan (the company due to start selling vintage cars which we will call Company B in this example – we will assume that a money of €200k is transferred from the other two supermarket companies) must have distributable reserves (i.e. assume if preference shares of €200,000 were subscribed for, then Company B must make €200,000 in profits in order to allow the shares to be redeemed).
In addition a dividend cannot be paid by Company B unless there is distributable reserves available to permit the dividend. The reason for this is that dividends cannot be paid on the preference shares unless there are distributable reserves available to permit such dividends (Section 117 Companies Act 2017 refers).
Therefore it is important to realise if the company that received the funds is not likely to make significant profits, then it will take a significant length of time in order for Company A to get back its initial capital unless they carry out a summary approval procedure to permit the reduction in the share capital.
Tax analysis
The tax consequences of this transaction for each company is as detailed below:
– The dividend at the market coupon rate received by Company A is not subject to corporation tax as it is a dividend which is treated as Frank Investment income for corporation tax purposes.
– The dividend paid by Company B is not tax deductible in Company B.
– Ordinarily the receipt of the dividend by Company A would be subject to a close company surcharge at a rate of 20% (unless the company pays it out as a dividend within a certain period). However, it is possible for this to be avoided if both parties make a Section 434(3A) TCA 1997 election. This election is made by Company A and Company B in the corporation tax return of both companies (completed by ticking a box on the Form CT1). Once this election is made then the dividend received by Company A is not taken into account in determining surchargeable income and in calculating any close company surcharge for that company.
Assuming the Section 434(3A) election is made the transaction is tax neutral for both companies. Where the election is not made, the 20% surcharge on any dividend received is payable (unless the company pays it out as a dividend within a certain period). Note before any dividend is paid, Company B should ensure that it receives a signed form V3 from Company A which will allow Company B to pay the dividend without withholding dividend withholding tax.
2) Subscribe for a golden share and subsequently loan the funds to the company
Company law analysis
As stated above where a parent/subsidiary relationship exists then the prohibition in Section 239 of Companies Act 2014 does not apply (Section 243 Companies Act 2014). Under Section 7 of the Companies Act 2014 a parent/subsidiary relationship exists where there is an ability of one company to control the composition of the board of directors of the other company. A share which gives the right to control the composition of the board is usually referred to as a ‘golden share’. Once such a share has been allotted, money can flow freely between both companies as the prohibitions in Section 239 of Companies Act 2014 no longer apply.
In this situation Company A would subscribe for an ‘A’ ordinary share. The rights of this share will give Company A the right to appoint and remove the board of directors of company B and no other rights. Once this share is in place, the loan can be given by Company A to Company B.
Tax analysis
If no interest is charged, then there are no tax implications (assuming the shareholdings are the same in both companies). Where interest is charged on the loan, the tax implications of this transaction would be:
- Company A would be taxed on the receipt of the interest payment at a rate of 25% with a further close company surcharge payable on the undistributed income after tax of 20% if a dividend is not paid to avoid it.
- Company B would claim a deduction for the interest cost at a rate of 12.5% or 25% depending on what the loan is being applied for (if the company is only an investment property holding company and the loan is used to purchase funds then a deduction will be available at 25% subject to certain restrictions). Before any interest could be paid, withholding tax of 20% would need to be withheld on any interest payment and paid over to the revenue where the two parties are not connected by way of a 51% shareholding. The withholding tax deducted will be reclaimable by Company A.
- As the owners of Company B will be the same as the other two companies then no gift tax issues will arise.
3) Summary approval procedure to permit otherwise prohibited loans
The summary approval procedure is a procedure dictated in Section 202 and 203 of Companies Act 2014. Where the procedures detailed in Section 202 and 203 are followed/performed, the company is permitted to carry on certain activities which would otherwise be considered restricted under the Act, which in this case would be the provision of a loan by one company to another connected company.
A summary of the requirements of the summary approval procedure as detailed in Section 202 and 203 are:
– Hold a board meeting no longer than 12 months from the carrying out of the otherwise restricted activity to approve the prohibited activity and the summary approval procedure.
– At this meeting, the majority of directors (75% or more of the directors) or where there are 2 or less directors then all of the directors agree to recommend to the members for the provision of the loan to be carried out and a special resolution be passed to permit the activity.
– At this meeting or a meeting held not earlier than 30 days before the approval of the members by special resolution, the directors should make a declaration in writing and this declaration should cover the following:
- Circumstances in which the transaction is to be entered into;
- Nature of the transaction or arrangement;
- Person(s) to or for whom the transaction or arrangement is to be made;
- Purpose of transaction or arrangement;
- Nature of benefit to the company directly or indirectly;
- Declarants to the state that they have made full enquiry into the affairs of the company and have formed an opinion that the company can pay its debts as they fall due for the following 12-month period
– The members pass a special resolution to approve the transaction.
– A copy of the declaration must be delivered to the CRO not later than 21 days after the date on which the restricted activity commenced. If it is not submitted within this period, it will invalidate the summary approval process (Section 201(3) of CA 2014).
Where it is found that the directors made the declaration without reasonable grounds for doing so the courts can direct that the directors be held personally liable for the debts without limitation (Section 210 Companies Act 2014). In addition, where the company is wound up within the 12 month period and all of its debts have not been discharged in full within 12 months of commencement of the winding up, it is assumed that the directors did not have reasonable grounds to make the declaration.
Tax analysis
From a tax perspective, the points in made in two above are relevant.
4) Create a tax group structure
As your client is the owner of both shops and he/she spent 50% of their time in both companies then if any of these supermarket companies were to be sold then retirement relief would not apply as Section 598 TCA requires a director to devote substantially the whole of his or her time to the service of the company in a managerial or technical capacity. Entrepreneurial relief would not be an issue if he had two companies and spent 50/50 time (and he is paid out of both companies – as if paid out of both it would support that he spends 50/50 time as this is usually what revenue look to when looking at the working time test). However, if a new company is now set up, and he spends time in that company it could potentially put him out of entrepreneurial relief.
An option may be that the two existing companies are put into a tax group whereby the current owner transfers his shares that he currently holds in both companies to another New Company set up for that purpose in a share for share transaction, then a tax group and company law group is created (as New Hold Co. will own 100% of the shares in the existing two supermarket companies and the owner/individual will own the New Hold Co). There are tax reliefs that would ensure no CGT or stamp duty applies (Section 584/586 TCA for CGT for individual and Section 80 SDCA would exempt stamp duty for the new Holding Company) as no cash changes hands, instead shares are issued as consideration.
Once this is done New Hold Co. can incorporate a New Co. to run the vintage car trade. Money can be loaned freely between the group companies or alternatively a dividend paid up by the existing supermarket companies that will then be subsidiaries of New Hold Co. and the dividend received in New Hold Co. can then be loaned back down to New Subsidiary Co.
As they are in a group under Company Law (as hold Co. owns more than 50% of all three subs), then money can flow freely. There are other alternatives here whereby not all of the shares may be transferred.
The advantage of this approach is that it means that now retirement relief may be available in the future. The period of ownership of the shares and the period of directorship in the two supermarket companies will pass over to the new shares issued in return by the New Hold Co.