One of the key tax planning opportunities available to anyone trading or investing is to consider using a company. The company tax regime is completely different to how individuals are taxed. Note only are the tax rates different but how the tax is calculated along with loss relief rules and methods of extraction are all completely different.
This applies to financial traders just as much as other traders. However one of the big differences for financial investors is that there is a special derivatives regime that applies to companies (known as the ‘financial instruments’ rules). These rules don’t apply to individuals so if you’re trading or investing in derivatives such as:
- Options
- CFD’s
- Futures
You’ll need to consider how the provisions effect you if you want to use a company.
No capital v trading distinction
The first key difference between holding options/CFD’s etc personally and within a company is that under the derivative rules for a company there is no distinction between holding as capital assets or trading assets. The receipts from most derivative contracts are brought into account as income. There is though an exception for:
- certain property derivatives and
- derivatives embedded in certain convertible and asset-linked securities
In these cases the receipts are brought into account as capital gains.
These won’t effect most traders though. However, although there’s no difference between capital and income under the company derivative rules, there is a difference between derivatives held for a trading use and derivatives used for a non trading purposes.
What is a trading purpose?
A company will have a trading derivative contract if it entered or acquired the derivative contract for the purposes of its trade.
So a financial trader that sells or deals in derivatives will enter into or acquire such derivative contracts for trade purposes.
But equally a company that uses a derivative for purposes that are ancillary to trading operations will satisfy the requirement. Examples are:
- a manufacturer using a commodity derivative to hedge raw material prices
- a company that borrows money for trade purposes, and then enters into an interest rate cap to protect itself from interest rate increases
- a company using a credit derivative to hedge the risk of a major customer running into financial difficulties.
A company will have a non-trading derivative contract if it is not a party to a derivative contract for the purposes of its trade. For example, if:
- it has no trade, such as a pure investment company, or
- as a trading company, it holds derivative contracts for investment or speculative purposes.
So although CFD or option traders will be classed as holding for a trading purposes, CFD or option investors will be classed as holding for a non trading purpose.
Trading purposes
If you deal in options/CFD’s etc as part of your trade then all receipts and expenses (including exchange gains and losses) from trading derivative contracts are treated as receipts and expenses of the trade. As such the profits would be classed as trading income and subject to corporation tax as usual.
This would apply to most traders in CFD’s and options.
Any losses on trading CFD’s or options would be classed as a trading loss and offset against other profits in the year (including gains) and if not utilised would be carried forward against future trading profits.
Options and CFD’s held for a non trading purpose
Receipts and expenses from derivative contracts not held for the purposes of a trade will be effectively taxed as interest income in the company (under the special ‘loan relationship’ provisions that apply to companies). If the expenses exceed the receipts there is then a ‘non-trading deficit’.
Note that the profit or loss on the ‘investors’ CFD/option activities in the company are treated separately from any trading activities. If there’s a profit it’s taxed as usual alongside any trading profit, but if there’s a loss this non trading deficit is relieved subject to special rules.
Where a company has a non-trading deficit (ie a loss on the derivative activities) it can claim relief:
- against any profits of the company for that period,
- by carry-back against any profits assessable as interest or under the derivative provisions,
- by carry-forward against non-trading profits of the next accounting period
Note that there is no offset for the derivative losses against any capital gains in the company.
In many cases the derivative provisions won’t have any impact on the tax payable though as the receipts under the CFD/Option rules will just be taxed as income in the company and any losses would be carried forward against future derivative profits.
Interest — the big difference!
The main difference will be in relation to interest deductions.
An investor in CFD’s will obtain no tax relief for any interest. By contrast a company would have interest deductible as a non trading debit which would reduce the derivative profits. So the fact that the derivative profits are for a non trading use won’t prevent there being an offset in the company for interest it sustains. Unlike for an individual the derivative receipts are not classed as capital but instead income, and are themselves taxed under the same provisions as interest.
So the interest would be a non trading debit which would just reduce the non trading credit (derivative income).
In addition if there are other trading profits in the company though there could be important repercussions. We’ll look at these in a separate article. Of course one of the big drawbacks would be the close investment company provisions which implement a 28% rate of corporation tax. Again though there are ways around this which we’ll look at separately.
So using a company can be particularly attractive in terms of interest deductions where you would be classed as an investor. The only occasion when individual investors would get a tax deduction for interest would be under the CFD rules for the deemed interest on the financing cost.
Anyone involved in activities with substantial interest elements eg margin trading could see advantages from using a company.
