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Decisions need to be based on whether after tax returns from cash management are trading or non-trading? Back  
Most corporates will be involved in cash management activities to some extent. Given the differential between the corporation tax rate applicable to trading and non-trading income, it is important that treasury managers are aware that the returns from their cash management and treasury activities may not necessarily be taxable as trading income, writes Jean O’Sullivan.
No matter what its business, every company is likely to be involved in treasury management activities to some degree, whether this involves, at its most basic level, the day-to-day control of cash and bank balances, or, on a broader scale, such activities as selecting financial instruments and investments for surplus funds, hedging financial risks etc.

In recent years, companies with surplus cash to invest have contributed to the rise in popularity of such money market instruments as commercial paper, certificates of deposit and highly rated bonds. The short term, highly liquid nature of these instruments makes them an attractive investment alternative. There has also been considerable growth in the derivatives markets, with, for example, daily turnover in Ireland’s over-the-counter currency and interest rate derivatives market doubling between 2001 and 2004 from $6.5 billion to $12.6 billion1. What treasury managers need to be aware of, however, is that the tax treatment of cash management and other treasury activities can vary from company to company.

Financial services companies
Cash management and other treasury operations carried on by standalone companies, where such activities represent part of their core activities, should qualify for the 12.5 per cent corporation tax rate. Where these activities are carried on by IFSC or Shannon companies whose certificates remain valid until 31 December 2005, the applicable rate is 10 per cent until that date.

Non-financial services companies
Treasury management activities carried on by non-financial services companies, for example, within the group holding company or in an operations company, may not qualify for the 12.5 per cent corporation tax rate. In order to so qualify, the activities must constitute a trade. Whether an activity constitutes a trade is a matter of fact, with each case being considered in the context of the specific facts.

Many treasurers may be of the view that the investment of surplus funds in various cash management products is part of the company’s overall trade, and that the income from such activity is trading income. This argument was rejected in the UK case, /Nuclear Electric plc v Bradley2, on the facts of that case.

In this case, a substantial provision was made for future costs (costs that would be incurred over more than a hundred years) and the company earned income from the cash put aside for this purposes. The crucial test applied in this case was why the funds were put aside; being put aside for current or short term liabilities would point towards trading. In this case, the judges all referred to the large sums involved, seemingly indicating that the larger the sum, the less likely it is to be for current or short term liability purposes.

There is also an Irish case in this area, JG Kerrane v N Hanlon (Ireland)3. In this case an ambulance manufacturing company, for budgetary reasons in UK health authorities, was prepaid for its ambulances. It put this cash on deposit; it claimed export sales relief on the deposit interest. As part of the judgement the judge asked, in the first place, whether the deposit interest was part of the trade; he decided it was not. In the High Court Murphy J said that “Whilst I fully accept that the opening and operating of the bank accounts by the respondents in the manner set out in the case stated represented a prudent procedure designed to meet the special circumstances which arose as a result of the advance payments made by certain customers for the purchase of goods, it would be difficult to accept that the interest payable on those accounts derived from the carrying on of the trade”4.

Capital gains tax or Case IV of Schedule D
Therefore, if a company’s treasury management activities do not constitute a trade, what is the result? Once-off speculative transactions will likely be subject to corporation tax on chargeable gains, at 20 per cent. By contrast, regular transactions, not sufficient to constitute a trade, but sufficiently regular to provide a regular source of income, are likely to be taxed under the rules of Case IV of Schedule D of the Taxes Consolidation Act 1997, at the 25 per cent corporation tax rate. This is because Case IV taxes ‘annual profits or gains’, not of a capital nature, not specifically taxed under any other Cases or Schedules.

That Case IV can be used to tax regular dealings in financial instruments is clear from the UK case of Cooper v Stubbs5 where two cotton brokers, over a number of years, branched out from the mere buying and selling of cotton into buying and selling cotton futures. The courts found that the two did not deal in future delivery contracts so habitually and systematically as to constitute the carrying on of a trade but that they were taxable on the annual profits under the UK equivalent of Case IV. In the Court of Appeal, Warrington LJ said that the trades were not taxable under Case I but were taxable under Case IV as: “…these dealings and transactions were entered into with a view to producing, in the result, income or revenue for the person who entered into them…”. Atkin LJ agreeing said: “For my part I can see no reason to doubt that they are profits or gains… It may very well be that transactions may be so carried out as to be nothing but in the nature of temporary investments repeated several times over, and something in the nature of capital accretions which could not be brought within the title or meaning of ‘annual profit or gain’ which to my mind must mean something which is of the nature of revenue or income, although I also think that it is plain that it need not be repeated every year so as to be a continuous source of income”.

This refers to the main difference between Case IV and capital gains tax. To be taxable under Case IV the ultimate return must be in the nature of income. Rowlatt J sums up the issue well: “‘Profits or gains’ mean something which is in the nature of interest or fruit, as opposed to principal or tree” and “it is quite clear that anything in the nature of a capital accretion is outside the words ‘profits or gains’.”6

The difficulty with Case IV is not only that the applicable tax rate is 25 per cent but also that companies cannot shelter Case IV profits with trading losses subject to the exception introduced in Section 54 Finance Act, 2002 which allows companies such sheltering on a value basis. Where a company incurs Case IV losses those losses may only be used against profits that are taxable under Case IV in the same year, firstly, and then against Case IV profits in subsequent years. On the plus side, the rules regarding the deductibility of expenses when computing Case IV profits are quite generous.

Deposit interest
Finally, it is useful to say a word or two in relation to deposit interest, given that most companies are likely, depending on their liquidity requirements, to have at least some of their surplus cash invested in deposit accounts.

According to Revenue, “The general position in relation to deposit interest is that it is prima facie passive income and is assessable as Case III/IV income. In order for alternative treatment to apply, there is a very high burden of proof on the taxpayer.”7.

Therefore, interest income is generally subject to tax at the 25 per cent corporation tax rate and, where it is received free of DIRT, is assessed to tax under the rules of Case III of Schedule D on an arising basis; otherwise it is Case IV income, assessed on an accruals basis.

Revenue do acknowledge, though, that deposit interest is assessable as trading income in the hands of certain financial services companies where the interest arises in respect of capital held to meet regulatory requirements or in respect of capital that is integral to the trade.

Most companies will be involved in cash management activities to some extent. Given the differential between the corporation tax rate applicable to trading and non-trading income, it is important that treasury managers are aware that the returns from their cash management and treasury activities may not necessarily be taxable as trading income.

1Central Bank Quarterly Bulletin 3 2005
2 [1996] STC 405
3 [1987] 3 ITR 632
4 ibid at 641
5 (1925) 10 TC 29
6 Both quotations are from /Ryall (IoT) v Hoare/ 8 TC 521
7 Revenue Information Notice, May 2001, Deposit Interest – whether a trading receipt?

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