We will look at Company Investments and Investment Bonds. We will introduce you to Don Gotti, the king of Dundalk. Companies will look to invest some of their excess cash. The purpose of this blog is to give you some information about a company investing in an investment bond. And comparing that to direct investing.
- Meeting Don Gotti
- Investing in shares
- Investment Bond
- Advantages and Disadvantages
- Other issues
Many companies have excess cash and are getting little or nothing from their banks. Why is that? The banks don’t need to give you an interest rate as they are laden down with cash. By giving you, the saver, a deposit rate they reduce their margins which will hit the bottom line!
Meeting Don Gotti
La di da di, la di
La di da di, see Don Gotti
The King of Dundalk
Man the King of Dundalk
Don Gotti is the man. Some call him the King of Dundalk. His company Gotti Enterprises Ltd [GEL] is a large employer in the area and doing well. Universally loved he’s highly involved with local charities and schools. Gotti’s people talk to our people and a meeting is set up.
There’s a buzz about the place on a Monday morning with the pending arrival of Don. We pull out all the stops. The best Nescafe gold blend and the chocolate digestives are on the tray. It’s not often we get a visit from a local dignitary with two minders. Don settles in and cuts to the chase.
GEL has €2 million in the bank. Working capital of €500k is the usual level. Don wants to invest €1 million in the next two years to modernise the equipment and facilities for the workforce. He wants to invest €500k and lock that away for five years or more. We go through the options when having excess cash in a company.
Don is independently wealthy, his pensions are maxed out and doesn’t need to extract more cash from the business. Don’s mate Roe Pesci has a stockbroking firm in Galway, called Pesci Waters. He’s pushing Don to buy shares. But Don isn’t sure what to do. Is it better for GEL to buy shares or invest in an investment bond?
Investing in Shares
Let’s assume that GEL buys a basket of 20 shares with €25k invested in each company. It is January 2024. Roe thinks the yield would be 3% per annum and that the dividend would increase by 10% each year. The income for the next 5 years will be approximately,
| 2024 | €15000 |
| 2025 | €16500 |
| 2026 | €18150 |
| 2027 | €19965 |
| 2028 | €21962 |
| Total | €91577 |
The tax rate in a company for investment income is 25%. Plus, there is a close company surcharge on this income which can increase the rate to close to 40%. The taxes on dividend income in a company can be complex and several factors will determine the rate. We won’t get into it for fear of losing you. We will use a rate of 25% to include the surcharge. As a result, the total tax will be €22894, leaving a balance of €68683 in the company.
Selling the Shares
We’ll assume that the value of the shares grows by 4% each year net of costs so at the end of each year the values are
| 2024 | €520000 |
| 2025 | €540800 |
| 2026 | €562432 |
| 2027 | €584929 |
| 2028 | €608326 |
In January 2029 Don instructs ROE to sell the entire shareholding. He wants the funds back in GEL as he plans to exit the business using a share buyback. Young Juan Gotti, the prince of Dundalk, will be the new boss and the coronation is imminent. GEL will pay Capital Gains Tax [CGT] at 33% on the gain, as part of its Corporation Tax [CT] return for 2029. After Roe’s commission, GEL gets back €605k. The CGT is as follows
| Sales Proceeds | €608326 |
| Less Commission | €3326 |
| Net Proceeds | €605000 |
| Less Cost | €500000 |
| Gain | €105000 |
| CGT 33% | €34650 |
| Net after tax | €570350 |
So, after all taxes, GEL has €639033 [€570350 + €68683]. But how would the figures pan out in an Investment Bond?
Investment Bond
Using the same income and growth rates as the basket of shares the bond performs differently. The income coming into the bond rolls up tax-free. As such, the bond will have the following values at the end of
| 2024 | €535000 |
| 2025 | €572300 |
| 2026 | €612082 |
| 2027 | €654544 |
| 2028 | €699903 |
The bond provider will look after the taxes and deduct tax at 25% from the total gain.
| Value after 5 years | €699903 |
| Cost | €500000 |
| Gain | €199903 |
| Tax 25% | €49976 |
| Net Proceeds | €649927 |
The investment bond wins as there’s an extra €10900 for Don to buy some Havana cigars with! Not a huge difference but a win, nonetheless.
Advantages & Disadvantages
The main advantages of a bond compared to direct investing are
- The investment rolls up tax-free
- The gross value at maturity is subject to exit tax at 25% and not 33% CGT
- Close company surcharge doesn’t apply to the income in a bond
- Life company is responsible for deducting the taxes. Taxes in a company can be complex with different rates and calculations.
- Less direct involvement in investment decisions
The main advantages of direct investing compared to a bond would be
- Annual income from shares comes into the company so there’s extra cashflow
- If there are losses on the share sales the losses could be offset against a future gain on another asset sale
- Better visuals on what the company has invested in
- No early exit investment penalties if owning shares. Some life companies offer low or no exit penalties.
An investment bond will suit a company where the business owner wants to lock away funds for a few years. And not have a huge involvement. The objective is to get a return that is better than deposit rates. Risk levels will come into play. The business owner must decide what life company to go with and what funds to invest in.
Don tells Roe he is going to invest in a bond and that he’ll do something with him in the future. Let’s hope that Don isn’t swimming with the fishes soon!
Other Issues
A strong balance sheet and access to cash are vital for a growing business. At certain stages of the life of the company, there is a greater need for cash. It’s important to be mindful of the circumstances of each company and the needs of shareholders. In Don’s case, he was looking to exit so wanted to get the cash back. GEL would use the funds to buy back his shares. Other factors to take into account are
- Excess Cash. Beware of this in a company succession scenario
- Effect on CGT reliefs. It can dilute Retirement Relief
- Sale of the business. Does it make it more difficult with investments in the trading company?
You can put in place a holding company structure to keep investments away from the trading company.
The above doesn’t constitute investment advice. The main purpose is to highlight some of the differences between the two ways of investing. It is important you get advice to understand the best options for your company.
Do you want to discuss options for excess cash in your company? If so, Start here
