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Multiple companies: Tax challenges and opportunities

Shared from Tax Insider: Multiple companies: Tax challenges and opportunities
By Alan Pink, November 2020

Alan Pink looks at the advantages or otherwise of running more than one limited company. 

In my practice as a tax adviser over the years, I’ve noticed that most entrepreneurs fall into one of two categories: the compulsive former of new companies on the one hand, and the ‘simplicity is everything’ brigade.  

Usually, the approach taken is motivated by reasons other than tax-efficiency. But tax planning is very important when considering how to set things up, as I’ll try to show in what follows.  

Planning for the long term 

The decision as to how you structure diverse business activities is a long term one, because it’s about the basic capital structure of your finances.  

Capital gains tax (CGT) tends to loom large in planning; or should do, if the entrepreneur is planning ahead sufficiently. From the point of view of CGT, the important distinction is between the single structure (even if this ‘single’ structure comprises a group of companies headed by a holding company) and the ‘standalone’ structure, where the individual shareholder or group of shareholders owns separately a series of companies which don’t form a group.  

The group structure appears, on the face of it, to have an unbeatable tax advantage over the standalone structure. This derives from what is known as the substantial shareholdings exemption. Basically, where a holding company sells a trading subsidiary it pays no tax on the capital gain. By contrast, if a shareholder sells a standalone company there is no exemption from tax in their hands. So tax at 20% (or 10% if business asset disposal relief (BADR) is available) will fall due. 

Which is best? 

Why wouldn’t everyone always choose to have the single structure, under which each separable part of the overall activities is in a limited company, which could be sold separately, tax free?  

In many cases this is a very sensible structure, but consider one fundamental disadvantage to it, from the point of view of the average owner-managed business (as opposed to large, quoted groups). This is that the proceeds from selling the subsidiary company go into the holding company, rather than into the hands of the individual shareholders. This means that, if the individual shareholder actually wants to have any of the money in their own private bank account, this has to be paid out of the holding company in almost certainly taxable form (unless the shareholder is non-UK resident for a long enough period).  

If it is possible to wind up the holding company, it may be possible to take the money out of the company at 20%, meaning that you have the same effective rate overall as in the standalone situation. But generally speaking we are going to be talking about a holding company which owns a number of different subsidiaries, and it is not going to be sensible tax planning to wind that up, because you realise capital gains on the whole value of the holding company by doing so, regardless of the fact that the other subsidiaries haven’t been sold. So it’s likely that in practice the shareholder will want to take the proceeds of subsidiary A’s sale out by way of dividend, with a high resultant income tax charge. All that glitters is not gold. 

We think the conclusion we are driven to is that the multiple, standalone structure is likely to be a better idea than the single group or company or company structure, for most owner-managed businesses, because of the CGT consequences. Needless to say this, like any general rule, needs to be looked at in detail in the specific circumstances of each taxpayer.  

Cash flows between companies 

It might be thought that one benefit of the single company or single group structure is that money can pass freely between the different divisions or group companies without tax consequences. It is certainly true to say, counterbalancing the CGT advantages I’ve described above, that a single company or single group structure can have the advantage of enabling losses in one company or division to be offset against profits in another.  

But simple financing cashflows between companies can actually take place just as easily in a standalone company structure as in a single/group structure.  

Example 1: Inter-company loan 

Roberta owns two companies directly in her own name, Newcastle Hairdressers Ltd and Gateshead Manicurists Ltd. An opportunity arises for her to buy the property that the latter company trades from, but it so happens that it is the first company, the hairdressing company, which has the necessary money.  

Rather than Roberta paying herself a dividend from the hairdressing company and then investing the money in the second company, which would trigger an income tax charge, she arranges for the money to be loaned directly from one company to the other.  

There’s a common misconception out there that such intercompany loans give rise to tax difficulties, with interest being either payable or imputed. However, where the loans in question are simply on intercompany current account (and therefore technically repayable on demand) and where the companies are small (‘small’ being a highly relative term) there is no requirement for interest to be charged by the lending company in this sort of situation.  

Parallel companies to maintain ‘trading’ status 

Finally, capital tax planning considerations are often in favour of creating a multiple standalone company situation where one didn’t exist before. I’ll conclude with an example of how this can happen, but it’s important to bear in mind that trading status for CGT and inheritance tax (IHT) purposes can be highly valuable in terms of tax planning.  

On sale of a trading company, BADR is available, meaning that each shareholder who is also a worker or officer of the company can half the tax rate from 20% to 10% on up to £1 million of gains. Also, the shares in a trading company can be given to someone else without incurring CGT, because ‘holdover relief’ is available for gifts of trading companies where it is not available for gifts of investment companies. Arguably, the IHT benefits of having a trading company dwarf the CGT benefits, though. If a company qualifies as trading it can be passed from person to person, including on death, with no tax charge at all.  

The definition of a ‘trading company’, typically of our muddled tax system, is radically different between the two taxes, though. For CGT purposes, the non-trading element in a company must be no more than 20% of its overall activities (it is difficult to know precisely how this 20% should be measured, but that’s another problem). For IHT purposes, effectively the investments side of a company’s activities can be as high as 49% without forfeiting the coveted trading status and thereby effective exemption from IHT.  

Example 2: Using surplus cash 

S owns all the shares in T Ltd, which runs a thriving trade in the manufacture of ornamental china penguins. The company is so profitable that it builds up a substantial cash balance, which S is unwilling to pay out as dividends because of the substantial income tax charge this would incur. A straightforward way of dealing with this ‘problem’ (a nice problem to have) would be for S to acquire investment assets with the ‘spare’ cash, thus making far better commercial use of the money. But as time goes on, and more and more cash is invested in more and more investments (e.g. buy-to-let properties) the trading status of T Ltd become increasingly threatened.  

So what S does is to set up a separate freestanding company, in which he also owns all the shares, (I Ltd). The spare cash is then loaned across from T Ltd and invested in a buy-to-let property portfolio within I Ltd. This intercompany loan is interest-free and repayable on demand.  

Whilst I haven’t seen any example where this has been tested, it seems to me that the loan balance in the books of T Ltd, whilst it isn’t a trading asset, doesn’t endanger T Ltd’s trading status for CGT purposes, because it is an inert intercompany balance which requires no management and gives rise to no income in T Limited.  

Company and LLP 

As a refinement to the above, I Ltd in the above example could become the company member of an investment limited liability partnership (LLP) and introduce its funds as equity capital into that LLP.  

The funds could then be invested by the LLP, and income and even gains from that invested amount could pass out directly to the shareholder, who could become a member of the LLP. But we are moving, here, perhaps, from GCSE to A Level tax planning! 

Alan Pink looks at the advantages or otherwise of running more than one limited company. 

In my practice as a tax adviser over the years, I’ve noticed that most entrepreneurs fall into one of two categories: the compulsive former of new companies on the one hand, and the ‘simplicity is everything’ brigade.  

Usually, the approach taken is motivated by reasons other than tax-efficiency. But tax planning is very important when considering how to set things up, as I’ll try to show in what follows.  

Planning for the long term 

The decision as to how you structure diverse business activities is a long term one, because it’s about the basic capital structure of your finances.  

Capital gains tax (CGT) tends to loom large in planning; or should do, if

... Shared from Tax Insider: Multiple companies: Tax challenges and opportunities
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