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.
The effect of the definition is that the vast majority of Irish private companies and many non-quoted public companies are deemed close companies.
Undistributed Non-Trade Income
Close company legislation strikes at undistributed investment and rental income. Most company trading profits are taxed at 12.5%. There is no further tax while the monies remain in the company. If they are distributed to shareholders, they may be subject to tax, social insurance and USC at their highest marginal rate, which will often be well over 50%.
Given the disparity between corporation tax rates and income tax rates, it will often be attractive to leave earned income in a company. They could be invested to make further returns. They could be used to expand the business of the company.
The retention of profits for reinvestment or otherwise is effectively encouraged in respect of trading companies. Such income may be necessary for investment or other company purposes. However passive (mainly rental and investment) income earned by close companies is subject to surcharges and special treatment.
Shareholders may wish not to declare a dividend in order to avoid paying tax at the personal income tax rate. However, the surcharge provides an incentive to distribute income.
The surcharge legislation levies a further surcharge of either 15% or 20% on undistributed passive income. It applies to undistributed rental or investment income. Investment income comprises dividend income. A limited category of dividend income from certain tax-exempt sources are excluded.
Avoiding the Surcharge
A dividend may be declared to reduce the surcharge. The dividend must be made within 18 months of the accounting period end. Deemed distributions, as set out above, are also deemed to reduce the company’s undistributed earnings for the purpose.
Where income is paid between companies both of which are close companies they may both opt by joint election to Revenue that the recipient is not surcharged. This may allow a trading subsidiary company to pay dividends to its holding company on the same basis on which it could retain them.
Companies which are entitled to the participation exemption on capital gains tax i.e. on 5% subsidiaries need not include dividend income from non-resident subsidiaries. In the case of distributions from Irish subsidiaries, they may each make an election by which the recipient is not subject to the surcharge but the subsidiary does not receive a deduction against its own surchargeable income i.e. it is deemed not distributed.
The calculation of the surcharge is intricate. All income is first calculated and current losses and trade charges are deducted. Losses forward and losses which can be brought back from the following year (leading to a recalculation and possible refund) are excluded. Excess rental capital allowances cannot be offset.
Rental and investment income is calculated net of nontrading charges (principally, bank interest for investments). Irish dividend income which is not normally included is included as part of this calculation passive income. The calculation of rental and investment income is based on the proportion of all income (we calculated on the above artificial basis) that such passive income bears to all income.
This passive income is reduced by non- trading charges (bank interest related to passive trade/ income) and the corporation tax (usually 25%) already paid on it.
Where the company also trades, a further 7.5% discount is allowed. The company must exist wholly or mainly for the purpose of carrying out the trade so that the rental and investment income is not the primary objective of the company.
From the above amount is subtracted dividends and deemed dividends which have actually been paid within 18 months of the end of the accounting period. The remaining amount is subject to a 20% surcharge.The surcharge must be payable with the corporation tax for the following year.
No surcharge is imposed if the excess distributable income over distributions is €2000 or less. Where the excess is over this amount the surcharge cannot be higher than 80% of the excess.
If the distributable income is less than the excess undistributed come then it is limited to the distributable income. That is to say where it is not possible to distribute because of previous losses or otherwise then the surcharge is limited to what is distributable. See our company law section in relation to distributable profits.
The final form of anti-avoidance legislation is aimed at close companies which are service companies. This is aimed at companies which exercise professions through a company. The charge applies to undistributed professional income. The surcharge is on 50% of the annual professional income. It is charged at the rate of 15%.
The surcharge applies to both active and passive income in this case. The passive income surcharge is as above. In addition, a surcharge of 50% is imposed on the active income.
The surcharge is due for the first accounting period one year after the end of the accounting period concerned. This will usually be the following accounting period for companies with 12 month accounting periods.This gives sufficient time to pick up on distributions made within 18 months.
A service company is one which carries on a profession or the provision of professional services, exercises an office or employment or its business includes the provision of services or facilities of whatever nature to either of the above types of companies, an individual or partnership who carries on a profession, a person who holds or exercises an employment or a person or partnership connected with the above.
A service company must be a close company.A service company is one where the principal part of the company’s income is chargeable to income as professional trading, services, employment or a combination.
The Revenue publish a list of activities which they describe as being professional services. Included are lawyers, architects, engineers, doctors, dentists, journalists, management consultants, auctioneers, accountants, opticians, journalists, actresses and others. This is not a definitive or complete list .
The principal criteria depends on how the income is earned. Generally a profession is one where persons are employed by the company on the basis of qualification and membership of professional organisations. The predominance of intellectual skills or manual skill employing intellectual skill is an important criteria. Companies which earn the majority of income from professional staff would be considered professional service companies.
The initial parts of the calculation is undertaken in the same manner as for passive income. One half of the trading/professional income is included. Once the 20% surcharge is applied to any passive income (if any) the balance of the trading income is subject to a 15% surcharge. This is reduced by dividends and distributions made in the 18 months after the accounting period. The same €2,000 exemption applies.
Half of distributable trading income i.e. income less charges post tax is surchargeable. Passive income is calculated as above. The 7.5% trading deduction is taken. Half of distributable trading income and the distributable and investment income is added. All distributions and dividends in the 18 months since the end of the accounting period are subtracted. A 20% surcharge applies to half the undistributable trading income net of corporation tax.
As with the passive income surcharge, the position is limited by reference to the profits actually available for distribution. The surcharge is reduced firstly for passive income and then for professional service income by the amount of the dividend or other distribution.
Distributions include redemptions and repayments of share capital which are treated as distributions. Distributions made in winding up are not distributions. The surcharge still arises and winding up may prevent a distribution being made thereafter.
FA 2013 Act increases the minimum amount of close company undistributed trading or professional income from €635 euro to €2,000 euro. Similarly, the minimum undistributed investments and rental income is increased to €2,000.
Close Company Anti-Avoidance
The Irish resident shareholders of a non-resident close company are taxable proportionately in respect of its gains. This is the case even though there may not be a distribution to the shareholders.
The transfer of assets by close company to trustees under a settlement may be deemed a distribution to the trustees. It applies where the settlement which may be a trust agreement or other arrangement, is one other than for the exclusive benefit of one or more persons who and neither members of the company nor relatives and does not allow the possibility of providing a any benefit to such persons.