Tax rules limit the extent to which shareholders may use close companies in order to postpone, reduce or avoid personal tax liability. Tax law defines certain companies to be “close companies”. The vast majority of private companies and many non quoted public companies are deemed close companies.
The effect of the definition is that the vast majority of Irish private companies and many non-quoted public companies are deemed close companies.
A number of very significant consequences flow from being classified as a close company. There are a number of distinct aspects to the legislation.
Benefits received by shareholders or persons connected to them are taxed as if they were cash dividends. Excessive interest paid by the company is deemed a benefit to the shareholder. Loans from the company to the shareholder are subject to restrictions and may be deemed to be income. Finally,certain types of passive income or professional service income is subject to a surcharge, if it is not distributed.
Definition of Close Company
The definition of a “close company” is designed to catch most companies, public and private, other than those with a genuinely wide dispersal of shareholders. The test is detailed and technical and it is very difficult to avoid being so classified.
A close company for tax purposes is an Irish resident company which is controlled by five or fewer so called “participators” or their “associates” or by “participators” who are all directors of the company, irrespective of their number.
A “participator” is any person having an interest in the capital of a company. This includes a shareholder, a person who holds or who is entitled to hold, share capital or voting rights, certain loan creditors, persons entitled to participate in distributions from the company and persons who are in a position to control directly or indirectly the assets or income of the company or secure that they may be applied for his benefit.
“Associates” of participators include their relatives including husband, wife, ancestor, descendent, brothers or sisters. In-laws [, nephews or nieces] are excluded. It includes trustees of settlements with which they are connected or which they or any of their relatives created. Trusts for the benefit of employees and pension funds are excluded.
“Directors” include persons occupying the position of directors irrespective of whether they have been formally appointed as such. It includes persons in accordance with whose instructions, the formally appointed directors act or are accustomed to act. It includes the manager of a company who is, either on his own, or with associates, the beneficial owner or able to control 20% or more of the share capital of the company.
Loan creditors do not include ordinary creditors. In this context, loan creditors means creditors who hold debts whose return is linked to the fortunes of the company. The will generally be investors and may also be shareholders. However, they may be more arms length than this and may be entities who have agreed to link their return to the company’s trading results.
A company is deemed to be an associated company if at any time [ within the previous year] it has control of the other or been controlled by the other or if both are under the control of a third person or company. “Control” is also widely defined. It includes a power or right to exercise or acquire control directly or indirectly of the company’s affairs including the greater part of any of its [ordinary shares; voting rights]; total share capital; total income of the company on a full distribution; or total assets of the company on a winding up.
Certain limited categories of company are excluded from the definition of close companies, even if they would come within it, under the above definition. They include
- companies not resident in Ireland,
- State owned or controlled companies,
- Companies owned or controlled by EU or DTA states themselves
- companies quoted on stock exchanges where at least 35% of the voting power is held by the public and not more than 85% of the voting power is held by at least five shareholders with more than 5% voting power each. (but with exceptions)
- certain companies controlled by non-close companies unless that company is one of the five or less participators.
Benefits Received by Participators
Most benefits received by shareholders and persons connected to them, are deemed a distribution and are taxable accordingly. The provisions also apply where assets benefits or expenses reimbursed exceed those actually incurred or where assets are sold at undervalue. The excess reimbursement or undervalue respectively are benefits.
The benefit and the corresponding company expense is effectively deemed to be a dividend to the value of the benefit benefits to the participators or their associates. This means that, for the company, they are not deducted in the calculation of profits for corporation tax purposes.
The company must account for dividend withholding tax on the value of the benefit at the standard rate. The company is obliged to remit tax on the deemed distribution (dividend equivalent) in the month after the benefit is made available, to the shareholder or other participator. The recipient is subject to income tax and levies on the receipt.
See the chapter on distributions and dividends. The concept of the distribution is much wider than that of a dividend. Distributions are always treated in the above manner; i.e. not allowed as a deduction in the calculation of tax, subject to dividend withholding tax and taxable as income in the hands of the recipient.
Interest paid on loan arrangements and loan securities in the company that have the characteristic of equity are treated as dividends under many circumstances.
The recipient shareholder (or other participator) is also assessable to income tax on the value of the benefit received. The recipient must account for the benefit in the same way as a dividend and pay income tax at his marginal rate of tax. He will obtain a credit for the tax paid by the company, in much the same way as with formal dividends
Expenses covered include entertainment services, accommodation and domestic services. It also includes any other benefits or facilities whatsoever.
Exceptions for Benefits
The following benefits are not deemed to be distributions:
- reimbursed expenses which are legitimate business expenses;
- those already deemed to be benefits in kind;
- expenses incurred in connection with pensions, lump sums or gratuities on death or retirement subject to compliance with conditions.
The exception for benefits taxed as employee or propriety directors benefits in kind covers payments already subject to income tax as benefits in kind. This will apply to many benefits where the recipient is employee or director. The close company provisions apply much more broadly
Interest paid to Certain Directors
Interest paid by a close company on most loans made by directors and associates is treated as a distribution. As set out above, the definition of “director” is much broader than those who formally hold the office of director.
[ The provision applies where interest is paid on loans by a close company or associate to a director or an associate of a director of any company which controls or is controlled by the close company or in which he has material interest]. A director has a material interest if he or any one of more of his associates is the owner or beneficial owner or able to control directly more than 5% of the ordinary share capital.
The company must withhold dividend withholding tax on the amount or value The recipient must account for income tax on the deemed distribution received. If also taxed on the interest received, he will get a credit for the dividend withholding tax.
Economic Return Limitation
There is a limitation which is designed to secure that interest which is an economic return on capital actually provided is exempted to this extent. The interest within the limit is calculated. Any excess interest over the limit is apportioned amongst the directors with the material interest concerned. Interest payments above the limit are deemed a distribution.
The limit is related to the share and loan capital of the company. It is 13% of the lower of the amount of all loans on which interest is paid in the accounting period to directors with a material interest or the nominal amount of share capital per the share premium account.
Interest in excess of the limit is treated as a distribution. Therefore it is not deductible the computation of taxable income. Dividend withholding tax must be withheld and paid to revenue.
Loans to Directors and Associates
Many loans to directors and persons connected with them are unlawful or are severely restricted under Companies law. Certain participators will not be subject to the company law restriction, although many will. The Companies Act 2014 has increased the scope for making loans to the directors under the summary approval procedure.
Apart from Company law considerations the close company tax legislation creates a tax liability on loans to participators. In effect the loan is treated as an after-tax distribution upon which tax is immediately payable. Provided it is fully repaid within five years the tax paid may be reimbursed by revenue.
The legislation applies to loans to participators (see definition above) associates of participators (see definition above) non-EU resident companies, companies acting as representatives for participators or their associates. There are anti-avoidance provisions designed to prevent arrangements with third parties which have the same practical effect as a loan or advance to one of these parties.
What constitutes a loan is very broadly defined. It can arise indirectly by reason of an arrangement with a third party. It can arise unintentionally, in any circumstances where the director (and associate et cetera as defined) incur a liability to the company.
Grossed Up Loan
Where a loan is made to a participator or an associate, the company must pay income tax on the amount of the loan grossed up at the standard rate, thereby treating the loan as if it was after tax. This means that the amount paid must be increased by an amount of taxation equivalent to the standard rate on the total of the tax plus the loan.
This tax liability is equivalent to a withholding tax liability and cannot be set off against the company’s tax liabilities.
When the loan is repaid the tax will be refunded provided this is done within  years.
By concession, the Revenue allow for loans within the period which are repaid by the filing date to be exempt from the provisions. They must nonetheless be reported. Revenue will be alive to the possibility of its abuse by loans being temporarily advanced and repaid around the filing date. Given the status of this exemption should be checked from time to time as it is not based on the legislation.
The loan is treated as income in the hands of the recipient. Although the company withholds income tax at the standard rate, it may also be chargeable as a benefit in kind to income tax at the higher rate as well as to PRSI and USC which may themselves be subject to an obligation to withhold tax via the PAYE system.
Where the loan is repaid the income tax may be reclaimed. However this must be done within the normal time for amending assessments (four years and the end of the year of assessment). If it is done after this time it becomes too late to reclaim.
If the loan is written off or released then the tax is no longer,potentially recoverable
There are exceptions for money lending and bank businesses;
The provisions do not apply to a loans to a director where are all loans by the company and associates to the borrower concerned and his/her spouse do not exceed €19,050 and the borrower works full-time and borrower does not have a material interest (5% of ordinary share capital (directly or indirectly held)).
The provisions do not apply where the debt relates to the supply of goods and services in the ordinary course of business of the company unless the credit exceeds six months or is longer than credit terms normally given.
The provisions do not apply whereunto the extent that the sums concerned are already subject to income tax in the hands of the recipient e.g as a benefit in kind to an employee or proprietary director.
Anti-avoidance provisions re-characterise interest as a distribution in certain circumstances. There is an exception from this treatment where the payment is to a company which is a resident of another EU Member State. Finance Act 2019 amends the provision to maintain this treatment for companies that are resident in the United Kingdom, in the event of a disorderly exit of the UK from the EU.
Where a company transfers assets or liabilities to its members or vice versa, the amount by which the market value of the amount or benefit received by the member exceeds the amount or value of any new consideration given by the member, is treated as a distribution. However, such transfers between Irish resident companies are not treated as distributions where one company is a subsidiary of the other or both are subsidiaries of another company which is resident in a “relevant Member State.” Finance Act 2019 ensures that the current treatment continues to apply to Irish subsidiaries of UK-resident companies, in the event of a disorderly exit of the UK from the EU.