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Julie Butler, FCA examines Companies Act 2006, and considers some of the potential implications for small businesses.

The Companies Act 2006 – The ‘Modernisation’

On 8 November 2006, Parliament enacted the Companies Act 2006.  The content is based on the recommendations of the Company Law Review Steering Group, Modern Company Law for a Competitive Economy, published in July 2001 and the White Paper, “Modernising Company Law” published in July 2002.  The group recommended a major revision of company law to make it more accessible to small businesses, with requirements as unrestricting as possible and easy to understand.  So has this been achieved?

The Act amends and restates many provisions of the 1985 Act with two thirds of that Act repealed.  Its provisions will cover companies registered under the new Act and the 1985 Act.  Implementation is expected to be in stages commencing in October 2007.

After Commons Committee stage the Bill contained 1226 clauses and 16 Schedules as a result of which it will be the longest Parliamentary Act in history.  The list of parts, chapters, clauses and schedules at the start of the Bill runs to 58 pages which could be described as “accessible”.

The Audit Report and the Criminal Offence

The principal direct impact of the Act on practitioners concerns the framing of the audit report.  There is to be a new criminal offence, which will apply where the auditor knowingly or recklessly includes in his audit report any matter which is misleading, false or deceptive in a material particular or where he omits any required statement within the report, e.g. the statement which confirms that the accounts are not consistent with the accounting records and returns.

There is an irony between the Companies Act establishing an incorrect audit report as a criminal offence at the similar time as the APB has issued an ethical standard on the provision of non-audit services such as taxation.

Tax services cannot be provided to an audit client where this would involve acting as an advocate for the audit client, before a tax appeal and/or court tribunal, in the resolution of an issue material to the financial statements, or where the outcome of the tax issue depends on an audit judgement.  This is a complete prohibition – there are no safeguards considered adequate to counter the perceived threat that arises through representing a client to the General or Special Commissioners.

In dealing with the threat arising from the provision of non-audit services, the APB has made a distinction between companies with informed management and others.

Online Incorporation

Companies House proposes to offer businesses the option to incorporate online during 2007.

Business Review

The implications of the Companies Act “Business Review” requirements have been well documented.

Accounts for the years ending March 31, 2006 onwards must contain:

• A fair review of the business and company; and
  
• A description of the principle risks and uncertainties facing the company.

Small companies escape the business review.

The requirement for all companies, other than those meeting the small company criteria, to include a business review in their Director’s reports is now set out in section 234ZZB of the 1985 Act and is effective for financial years which begin on or after April 1, 2005.

“Key performance indicators” (KPIs) are factors that measure effectively the development, performance or position of the business of the company, (s234ZZB (5) CA85).  This definition is rather vague and leaves it open to the directors to set such KPI’s as they see fit.  Whilst undertaking this task the tax position of the company or LLP cannot be overlooked. The DTI guidance says that it is for the directors to decide exactly what information to include about their particular company provided that the information is relevant to an understanding of the business.  In the absence of a requirement to use the same KPIs on a year-by-year basis it leaves scope for abuse, such as selectively using those KPIs that show the company’s performance in a favourable light and this includes tax.

Transactions with Directors requiring approval of members – the loans and connected parties

The Companies Act 2006 provisions govern approval by members on the following subjects:

Long-term service contracts, substantial property transactions, loans, quasi loans and credit transactions and payments for loss of office brought together.

Loans, quasi-loans and credit transactions (defined as in the 1985 Act) to a director or connected person of the company of holding company are no longer illegal for relevant companies but must only be made if approved by the members of all companies.  In the light of the previous detail on connected parties (for the definition see below) this might raise some interesting considerations on the exact definition of family relationships.

The resolution to be approved by the members must set out:

• The nature of the transaction with the director
  
• The amount of the loan or quasi-loan and the purpose for which it is required
  
• The extent of the company’s liability under any transaction connected with the loan or quasi-loan (clauses 198-203).

Approval for Loans

No approval of the members is required for the following Loans:-

• Loans, quasi-loans, credit transactions and related guarantees or security to meet expenditure on company business:  The total value of transactions under this exception made in respect to a director and any person connected to him must not exceed £50,000 (previously to be repaid in six months by a private company and limited to £20,000 in a relevant company) (clause 203)
  
• Money lent out to fund a director’s costs for legal proceedings: proceedings in connections with negligence, default breach of duty or breach of trust by the director in relation to the company) (clause 204) or in connection with regulatory action or investigation (new) (clause 205)
  
• Small loans and quasi-loans: as long as the total value of such loans and quasi-loans made in respect of a director and any person connected to him does not exceed £10,000 (no time restriction on quasi-loans and all extended to connected persons) (previously £5,000) (clause 206(1))
  
• Small credit transactions: as long as the total value of such credit transactions made in respect of a director and any person connected to him does not exceed £15,000 (previously £10,000) (clause 206 (2))

The Companies Act 2006 has focused on the legality, approval and disclosure of the loans to directors as set out above.  How will the tax legislation deal with these changes?

Tax efficient withdrawals from the company

Where does this leave tax compliance and tax planning for the average owner managed business?

Can it be said that this revision to company law does make it more accessible to the small business?  On the basis that UK GAAP (Generally Accepted Accounting Practice) = tax treatment then where will this leave the tax treatment of loans to directors?

The effect of accounting standards on taxable profits has been well documented. Will this accounting standard stamp the tax treatment of these loans?

Copies of the Act and some excellent explanatory notes may be downloaded by clicking here (external site). Further information of CICs, including a copy of the draft regulations can be found by clicking here (external site). 

How will the companies requirements surrounding withdrawing monies from the Company impact upon tax planning and the whole subject of tax efficient withdrawals from the Company and the role of the tax adviser?

Connected Persons

Persons connected to a director will include under the 2006 Act:

• The directors spouse or Civil Partner;
  
• Any other person with whom the director lives as a partner in an enduring family relationship excluding grandparents, grandchildren, siblings, uncles, aunts, nephews and nieces – this is similar to, although less strict than, the FRS 8 concept of ‘family members or members of the same household who may be expected to influence or be influenced by’ and more strict than the IAS 24 concept of ‘family members’
  
• The director’s children or step children;
  
• The children of any other person with whom the director lives in an enduring family relationship who are not the director’s step children and have not attained the age of 18;
  
• The director’s parents;
  
• A body corporate with which the director is connected (as defined in section 254 – interested in 20% of share capital or entitled to control 20% of voting power);
  
• A person acting in his capacity as trustee of a trust-
  i) the beneficiaries of which include the director or a person who by the family link is connected with him, or
  ii) the terms of which confer a power on the trustees that may be exercised for the benefit of the director or any such person, other than a trust for the purposes of an employees’ share scheme or a pension scheme;
  
• A firm that is a legal person under the law by which it is governed and in which-
  i) the director is a partner,
  ii) a partner is a person who, by virtue of the family link etc is connected with the director, or
  iii) a partner is a firm in which the director is a partner or in which there is a partner who by the family link etc is connected with the director.

This will involve much greater transparency and much harder work for all concerned – directors and auditors.

The related party transaction

What of the need to disclose related party transactions in the notes of accounts?  How easy for an enthusiastic HMRC officer to obtain vast information from the notes to the company accounts?  Perhaps some family companies have enjoyed the ability to direct company profits to various (previously distant) family members/connected parties in a very tax efficient manner.  Will the disclosure of connected parties help the detection thereof?

The Nervous audit/accounts clerk and the enduring family relationship

Please also feel some consideration for the innocent (possibly nervous) audit clerk who, ever mindful of the Companies Act 2006 disclosure requirements, has to ask the confident (and possibly scary) managing director the status of civil partners and the children of the people with whom the director lives.  It might just be that senior members of the accountancy practice have failed to leave full notes on the director’s ‘household’ needed for Companies Act 2006 compliance.  Perhaps the questions should be delicately asked by the partner in charge of the audit…