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I have recently acquired as a new client a building company. Basically it is a one-man limited company that operates on a reasonably small basis (turnover approximately £250,000) and there are some employees and sub-contractors.
The director tells me that the shares in his limited company are in fact owned by a holding company and that he owns all the shares in that. Other than the shares, the holding company does not appear to hold any assets.
About two-thirds of the profits seem to be paid by the trading company up to the holding company, which then pays these out to the director as remuneration and dividends. The balance of the profit remains in the trading company.
I am not sure that I see any particular point in this relatively complicated arrangement, but my new client tells me that he understands that many of the limited company clients dealt with by his previous accountants have this set-up.
I can see the point in such an arrangement if the trading company is risky and the holding company holds all the assets, but am I missing a trick taxwise?
Can Taxation readers advise me whether there are any good tax reasons to adopt this structure? I am now starting to wonder if this is something that I should be suggesting to my own limited company clients.
Query 17,542 – Holden
Reply from Thicket
Holden seems to be basically correct in his understanding of the situation. The first consideration must always be the commercial factors that might influence the form of the trading vehicle.
Builders are exposed to a number of commercial risks and will often benefit by operating as a limited company.
This has the potential to limit personal liability if something were to go wrong in the business; for example, if a fixed-price contract were to over run, or a customer went bankrupt owing a substantial sum of money, or if there was a significant claim for faulty work.
I would consider imposing a holding company between the owner and the main trading company if there were valuable assets to protect from creditors.
I have certainly seen this where, for example, the company’s own premises, tools and other fixed assets, etc. are held by the parent, leaving the subsidiary to contract with the outside world.
If there are two sides to the business, for example contract building work for others and property development, then these are two different businesses and should be kept separate from a risk management perspective. If bank borrowing is involved, then security will be an issue.
If a fixed and floating charge with cross guarantees is given then even a group structure will fail to provide protection from any recovery action taken by the lender.
For tax purposes, a parent can either operate as an active company with its own ‘trade’ of providing management services and hiring equipment to the subsidiary, or it can be passive.
There will be valuable capital allowances which might go to waste unless the asset-owning company has a taxable source of income. This indicates that it will need to have a trade of its own.
Directors’ remuneration can go through the parent and some confidentiality over the whole group’s profits might be preserved – which might have some commercial advantages when tendering for work.
First year plant and machinery allowances (FYAs) are not available to the parent where the equipment is hired out and used by the subsidiary, and the recent temporary reintroduction of FYAs will impact here.
The main concern facing the group structure is the reduction in the profit limits at which the small company rate of corporation tax ends and marginal rates begin.
The limit of £300,000 has to be divided by two to become £150,000. It then becomes necessary to try to ensure that taxable profits arise reasonably equally within each company.
These are all factors that can impact upon the company as it grows and profits and commercial risks are at levels which warrant taking limiting action.
A group structure comes at a price. There will be two sets of accounts, annual returns and tax returns to prepare, tax payment deadlines to be met, etc. Is the hassle worthwhile?
Ultimately, it will be for the client to judge (particularly when he receives his accountant’s fee note).
I certainly would not force a relatively small builder client into this structure. No tax advantage springs to mind. Risk limitation may be a factor, but that will be something to discuss with the client.
Reply from The Snark
I don’t think Holden is missing a trick, as he puts it. I cannot see any tax advantages in the structure as described, especially given the size and nature of the business; indeed, I think quite the opposite may be true.
The two companies are clearly associated within the meaning of TA 1988, s 416 so that the availability of small companies’ relief under s 13 will be restricted.
Although a company which carries on no trade or business can be excluded, I am not convinced that this is the case here. The holding company seems to do more than hold shares in the subsidiary and receive and pass on dividends.
Therefore the small company band of profits for each company is only £150,000. Given the scale of the business, this may not be a problem now, but it could be in the future.
We are told that the trading company pays about two-thirds of the profits to the holding company. We are not told when or how; it could simply be by way of dividend which would have no tax effect for either company.
I rather suspect that is not what happens. The payment is more likely some sort of management charge. If that is the case, I would question the rationale for it. What does the holding company do for the payment?
If the payment varies with the profit of the trading company, rather than any other factor, how is it commercially justifiable?
In other words, is it a valid deduction for the trading company and taxable income of the holding company?
Whatever, the technical niceties, I think that in the event of an enquiry HMRC would not get too excited given the relatively small amounts involved and the deduction on one side balanced by income on the other.
If this is a ‘one-man’ arrangement, which company employs him? Almost certainly there will be no formal arrangements, but he is simply a director (officer appointed under the Companies Acts) of each one.
Why is it that the holding company pays him? Does he provide some service through that company for which he should be rewarded? Is the amount large enough so that income tax and National Insurance ought to be deducted under PAYE?
If so, which company deals with it? I imagine that the PAYE scheme for the other employees is in the trading company. Does this mean that the holding company is only acting as agent in paying what is really remuneration for services provided to the trading company?
If it is believed to be the holding company which is making the payment, is this company able to deduct the remuneration from its profits? Probably so, but this seems an awfully convoluted arrangement to achieve very little.
Of course, if the payment from the trading company to the holding company is by way of dividend, there will be no profits in the latter from which the director’s remuneration can be deducted.
I think Holden has ‘hit the nail on the head’ with the comment in his last paragraph: this is actually nothing to do with tax at all. I have certainly seen other (larger) development companies with similar arrangements.
Usually, all assets of value will be ring-fenced in the holding company with just the development work in the subsidiary.
Sometimes, successive developments are in successive companies. The object is asset protection and limited liability. Given what we are told of this business, this seems to have little relevance here.
The facts all seem a bit vague. If Holden has acquired the trading company as a client, surely he must have acquired the holding company as well.
He ought to obtain accounts and tax computations for both to see how the inter-company payments are actually treated.
Even then, I suspect there is no real purpose to the arrangement and I would be inclined to collapse it into a single company. This should have no adverse tax consequence, but will certainly reduce administrative costs.
A closer look... VAT and management charges
The Snark’s reply touches on management charges between companies. What may often be overlooked are the VAT implications of such charges and HMRC’s VAT Manual (V1-3) at 10.5 advises as follows:
‘Accounting entries or invoices alone are not sufficient evidence to establish that a supply has taken place. The rules governing whether a supply is made ... are also applicable here. The three main points for management charges that have to be considered are:
- Do the supplies exist? Does the value given represent any actual supplies made, or is it just a book figure?
- Who is making the supply and what supply is being made?
- What is the value of the supply? How is the supply costed and does the value have any relation to the supply being made?
‘With holding companies, “management charges” may be the only supplies that appear to be made. If these relate to supplies actually made the holding company is entitled to register for VAT and reclaim input tax. Therefore it is necessary to check that supplies are actually being made in order to confirm the registration is valid. Indicators that a supply is not being made include:
- No staff are employed by the holding company.
- The directors are common to both the holding company and the recipient of the services.
- The company has no business premises or assets.
- There is no visible or documentary evidence of supplies other than the invoice and/or bookkeeping entry.
- The trader is unable to specify what supplies are covered by the charge.
‘If you decide that a supply is being made it is likely to be a continuous supply of services. For information on how this affects tax points you should consult V1-11.’
The manual also refers to Newmir plc (10102) and Polysar [1993] STC 222, where holding companies were held not to be carrying on any commercial activity.
