16 minute read

How Small Businesses Can Use Holding Companies To Save Tax

Introduction

Holding Companies are always a hot topic when it comes to tax planning, however many accountants are still struggling to give their client’s effective advice to get the most out of them. A point I wanted to make in this article is that a holding company without the right structure and planning in place can do more harm than good, so you really need to establish firstly if you need one at all and secondly get the restructuring right so you don’t end up with tax, legal and banking issues that impact your business.

While you’re here why not check out our Ultimate guide to tax deductions available for limited companies, it’s packed full of tax saving ideas that many accountants don’t even know about.

Key Takeaways

Holding companies provide vital asset protection for small businesses by separating valuable equipment, cash and property from the operational risk of the main trading companies which are vulnerable to creditors in the event of an insolvency.
Using holding companies gives you tax advantages such as savings due to tax free intercompany dividends, the Substantial Shareholding Exemption for capital gains and strategic use of intercompany loans and Special Purpose Vehicles (SPVs).
A holding company structure gives you flexibility in business partnerships and family run businesses by allowing different wealth extraction strategies, minimising conflict and utilising tax free allowances.

1. What is a holding company?

Holding companies are a type of limited company with only one purpose, which is to hold equipment, cash, property, shares and other assets.

The absolute number one rule of having a holding company is not to let it get struck off! If that happens all your assets pass to the government so it is essential to stay on top of your filing requirements.

Many people overlook how vital it is for a holding company to not undertake any form of trading activity, as trading activity creates risk and risk endangers assets. Since the introduction of scaled Corporation tax rates, trading through a holding company can also have the undesired effect of potentially increasing your overall tax bill.

Whilst the holding company can be straightforward to incorporate at Companies House for a modest £50 fee, there is effort needed to produce the paperwork for the transfer of shares and to ensure that you aren’t caught out by capital gains tax or stamp duty, and ultimately to ensure the transfer of assets is legally valid in the first place.

What is a subsidiary?

In general a subsidiary is a company that is owned by another company, in most cased where small businesses are concerned a subsidiary will either be the main trading business or an SPV (special purpose vehicle) created to hold properties.

Reasons you will want to use a holding company

Protecting your assets and cash: By putting your assets in a holding company they are separated from the day to day operational risk of the business, providing a safe haven against potential legal claims or creditor action.
Tax advantages: By planning and structuring their finances correctly they can take advantage of various tax benefits such as transferring profits between companies within the holding structure without incurring additional tax. This can save them a lot of money and simplify the management of the business.
Flexibility with business partners and family members: By using a holding company you can have different profit sharing, investment and business strategies for each individual, which can avoid conflicts that may arise from different objectives or visions for the business.

2. Protecting your assets and cash

Piercing The Corporate Veil

The entire premise of using a holding company is based on the concept of the corporate veil, whereby the issues of one company can’t legally effect another. Many business owners are reluctant to acknowledge the risk associated with their business, however Covid proved how vulnerable even the strongest businesses could be to a change in the economic and social climate.

There are many risks you just can’t insure yourself against and as many instances where your insurance could be invalid, even if you had it. When your business is in trouble or it has picked up liabilities, it can be too late to try and protect or extract your cash at that point as it is a criminal offence to prioritise yourself as the owner of the business over your creditors or to continue trading if you’re insolvent.

Having your cash and property secured in a holding company by paying it up as dividends can be a great way to build up an emergency fund in case you had to start over, without triggering unnecessary dividend taxes.

Special Purpose Vehicles (SPV’s)

Special Purpose Vehicles or SPV’s are a type of subsidiary that can be part of a holding company structure and often hold assets like properties. A holding company can loan money to an SPV, which then uses it as a deposit for property loans. This strategy is becoming more popular now that there are a lot of tax increases related to owning a rental property personally, plus with the additional benefit that cash can be utilised for property without it having to leave your group structure and trigger dividend taxes.

If you’re planning to borrow money to fund your property investments then you may find it impossible to proceed without an SPV, as many lenders won’t want to lend to a trading business as it could put their interest in the property at risk if a creditor forced a liquidation.

If you’re investing using only your own cash and don’t need any external finance than it is absolutely vital that you do it through an SPV and not your main trading business. In addition to the reasons above relating to creditors, the tax consequences of losing your trading status when it comes to capital gains and inheritance tax are significant.

3. Tax advantages of holding companies

A holding company isn’t just a safe place for your asset. It’s also a tax efficient way to do things, here’s why:

One of the biggest priorities for the government and HMRC is to ensure that the tax system doesn’t stifle business investment, but encourages it. The rules around tax are therefor designed to collect money when a private individual withdraws it for personal use, but there to provide relief when it is diverted for business growth or long term wealth creation. The government choses to forgo the quick wins today, so they can support the growth and get a larger cut of the pie later.

This means that if you as a business owner are willing to delay gratification and not withdraw everything you earn straight away, you can ensure that you use up your various tax allowances and basic rates efficiently. A good example of this is only withdrawing a salary and dividends up to the point you pay higher rate tax and then stopping, which is currently £50,000 a year.

Overall there is a certain amount of smoke and mirrors here as eventually you will have to pay tax to get access to the wealth you’ve created, however you have some control of when and at what rate that is.

There are three main tools you have when it comes to group structure that can help you save tax:

Franked Investment Income (tax free dividends)

A dividend between a subsidiary and it’s parent holding company is tax free, this is in contrast to if it paid you a dividend as an individual which would be taxed at your marginal dividend rate. This is highly advantageous if you had large cash reserves building up within your trading company and were worried about the risk of it sitting there. Regardless of how big the dividend is, there wouldn’t be any tax on it at the point your holding company received it.

This can then be allocated to various group projects, whether it be reinvesting into the business, funding new ventures or even paying shareholder dividends. The ability to move profits without tax implications gives you a lot of financial flexibility and can be a powerful tool in corporate strategy and planning.

Intercompany Loans

Within a holding company structure intercompany loans are a way to move cash around. These transactions allow the flow of funds between the holding company and its subsidiaries without tax liability. They are particularly useful because dividends can only move cash up to a holding company, so there are often situations when money needs to flow the other way if for example further investment is needed or to provide a trading business with funds in the event of an emergency.

As a general principle it is important to ensure that loans are only made from a holding company down to subsidiaries and not the other way around, or between subsidiaries. If things go wrong with a subsidiary that has a loan owed to it by another company in your group, then creditors can try to seize this outstanding loan as an asset.

The SSE or Substantial Shareholding Exemption allows companies to sell significant shares in another company without paying corporation tax on the gains from that sale provided they meet certain criteria. The main criteria are that the selling company has held at least 10% of the shares in the subsidiary, for at least 12 months in the 6 years prior to selling those shares.

Quite often when someone sells a business, they will seek to reinvest in a new business or start one from scratch. The SSE allows the full value of the sale of the business to pass to the holding company without being diminished by tax, this then maximises the amount available for reinvestment.

In the event you wanted to trigger the capital gain and distribute the funds to yourself, you could potentially have the holding company liquidated (MVL) and the money in the company distributed to yourself. If this was done alongside a business sale then you would still benefit from Business Asset Disposal Relief.

Why offshore holding companies are a bad idea

Setting up a holding or management company in a country where the corporation tax is lower than the UK might seem like a good idea because you can charge your UK business a management fee from the company abroad and lower it’s profits, then transfer the profit to the country where the taxes are a lot lower.

But this is aggressive tax avoidance and may be ruled out by the tax tribunals due to the targeted anti avoidance rules in effect (TAAR’s). Avoid offshore holding companies unless you actually live in that other country!

4. Flexibility with Business Partners

Since dividends are paid out in proportion to your share holding, you can often end up in a position where you may be forced to take dividends because your business partner wants to take them. Perhaps because they have more of their basic rate of tax available than you do, or have family members involved who can withdraw the funds at tax efficient rates.

In this scenario you have a choice to take the dividend even though it might not be tax efficient or waive it completely, which would be even worse as you then won’t be rewarded fairly for your share of the work.

Individual holding companies can be a great solution to this problem as it allows dividends to be paid up to each partners company tax free and then gives them the flexibility to reinvest or extract it as they see fit.

5. How to create a holding company

Steps Involved in The Set Up

Value your trading company – Both the application for clearance and the stock transfer form require a value for the business to be stated. Whilst I would argue that a precise value calculated by a surveyor isn’t necessary as it is immaterial to the commercial reasons you have provided for the exemption, it is worth noting that HMRC could use an inaccuracy here to set aside any advance clearance they have granted you.
Apply for advanced clearance (optional) – This must be done before you start the set up and you have to await a reply, otherwise it can be rejected.
Incorporate your holding company – Use SIC code for holding Companies, you are the shareholder from the start
Complete a stock transfer form – Dated the date of incorporation of your holding company with the shares in the holding company as consideration.
Send stock transfer form to HMRC for stamping – You may have to provide commercial reasons for the S77 exemption if you didn’t apply for advanced clearance. It might be worth just paying the stamp duty as it is often cheaper than getting an accountant to apply for the S77 relief.
File a Confirmation Statement – Showing that the holding company now owns the shares in the trading company
Update company registers and share certificates
Set up holding company bank account – This can come with complications due to the KYC requirements banks are obsessed with, it is really recommended that you approach your primary bank for the trading company first as they will have better visibility on your activity.

Relief from Capital Gains Tax and Stamp Duty

At the beginning before the holding company exists you will own the shares in your trading business personally, which means that to transfer those shares to your holding company you must either sell them for cash or exchange them for something.

The usual route to achieve this transfer is via a mechanism called a share for share exchange. This means that you are exchanging your shares in your trading company for shares in your holding company instead. After the exchange, you will own your holding company and your holding company will directly own your trading company.

Usually in the tax world, the transfer of an asset like shares to anyone other than a spouse is considered a sale at market value and taxed as such, however in order to ensure that UK companies have the flexibility to restructure their groups as needed, certain reliefs are available. Relief from capital gains tax is usually obtained under Section 135 TCGA 1992 and from stamp duty under S77 Finance Act 1986.

It is worth noting that the reliefs from stamp duty and capital gains are based on different criteria and there may be instances where one relief applies but the other doesn’t. In particular the capital gains relief only requires you to acquire over 25% of the target trading company, whereas the relief from stamp duty means you must own all of it after.

It is worth noting that Section 137 TCGA 1992 adds a clause that states the restructure must be carried out for genuine commercial reasons where the primary purpose of the restructure isn’t to obtain a tax advantage. If a tax advantage is incidentally obtained, this doesn’t subsequently void the reliefs available but it can’t be the main reason for the restructure.

Criteria for Exemption TCGA92/S135

Acquiring company B either holds, or as a consequence of the exchange will hold, more than one quarter of the ordinary share capital of target company A, see TCGA92/S135(2) Case 1 below, or
The shares or debentures are issued as a result of a general offer made to the members of company A, or to any class of them, in the first instance on a condition which if it is satisfied would give company B control of company A, see TCGA92/S135(2) Case 2 below, or
Company B holds, or as a consequence of the exchange will hold, the greater part of the voting power of company A, see TCGA92/S135(2) Case 3.

Criteria for Exemption S77

The transfer must form part of an arrangement by which the acquiring company acquires the whole of the issued share capital of the target company.
The consideration for the acquisition must consist only of the issue of shares in the acquiring company.
The shares must only be issued to the shareholders of the target company.
The acquisition must be effected for bona fide commercial reasons, and it must not be part of a scheme or arrangement a main purpose of which is the avoidance of certain taxes.
The shareholders of the acquiring company after the acquisition must be the same as those of the target company immediately before the acquisition.
Their proportions of shareholdings in the two companies must be the same (or as nearly as may be the same).
The classes of shares in the two companies must be the same.
The proportions of shares of any class in the acquiring company must be identical to those of the same class in the target company.
At the time the instrument mentioned in s77(1) is executed there are no disqualifying arrangements. Further information can be found at STSM042460.

Genuine Commercial Reasons TCGA92/S137

Maximise cash available to reinvest in new business ventures by lowering the groups tax bill
Create a group structure so that intercompany losses can be utilised and VAT management can be simplified
Protect business assets from trading risk
Create flexibility for wealth extraction and reinvestment where multiple partners are involved

Do you need advance clearance?

As with many things with tax, you often don’t get any feedback from HMRC until it is too late and they have opened up an enquiry into your actions and they seek to reverse them, recover back taxes, plus interest and apply penalties.

It is possible to request permission in advance in the case of reconstructions like this and ask them to confirm that they agree with your commercial reasons and they will not object. If they do object in advance, then at least you haven’t undertaken a course of action that could be very costly later on and you can supposedly sleep a little easier at night.

Or if they do object, you can then be proactive in taking them to a first tier tribunal and forcing their acceptance.

Before you even consider advanced clearance, just ask yourself the question: Is there any risk? If your business is too new or you’re confident it has no substantial value then you really have nothing to worry about.

Here are the reasons I’m generally against applying for advanced clearance:

For a small business the reasons for the exchange are generally very standard and there are precedents that indicate there are no real grounds for the challenge.
It is time consuming and the wait to receive confirmation can be around five weeks if there are no queries, this can create a hold up in your plans.
Whilst our fees are currently in the region of £2,500 for the application, there are many specialists that charge around £7,000 and the costs for seeking permission are often greater than the penalties for getting caught out.
If HMRC do object then it can be a monumental pain to shift their position via the tribunals service. They are far less likely to contest the transfer of shares and the reliefs retrospectively so why force their hand.

6. When don’t you need a holding company?

Holding companies aren’t for everyone, after all why add complexity and accounting fees if you don’t need to. If it’s just you in the business and you never have any cash reserves or assets building up in your trading company to protect or reinvest, then you really don’t need one.

You can always add one later on.

7. Summary

A holding company is a good idea for small business owners who want to protect their assets, save tax and have more flexibility in how they run their business. It’s like a safety net that keeps your most valuable assets safe if your company hits financial trouble while also giving you clever ways to manage your money and reduce your tax bill.

As we’ve come to the end of our holding company guide remember every business is different. What works for one won’t work for another so always get advice from the experts. With proper planning and the right strategy a holding company could be just what takes your business to the next level.