UK: Focus - Summer 2013

Last Updated: 23 September 2013
Article by Paul Wyse

FUNDING GROWTH GOVERNMENT INITIATIVES SUPPORTING BUSINESSES TO FUND THEIR GROWTH

By Erin O'Shaughnessy

Businesses continually require support to fund critical business activities and to develop and exploit opportunities for growth. In recent years, bank credit has been difficult to obtain and businesses have looked to explore other avenues for funding.

The Government is targeting the small and medium sized enterprise (SME) and start-up business sector. Initiatives such as the Ireland Strategic Investment Fund (ISIF), the Credit Guarantee Scheme and the Micro Enterprise Finance Fund should assist viable businesses.

Enterprise Ireland

Enterprise Ireland (EI) is the most significant source of support to SMEs in Ireland. In 2012, EI invested €64m in Irish businesses through equity and venture capital and indirectly, €645m through 11 seed and venture capital funds. In addition, EI invested €27m in strengthening the leadership capability of Irish enterprises and €87m in science and technology infrastructure in third level/research and enterprises sectors.

Companies that qualify for EI support are as follows.

  • High Potential Start-Up (HPSU) companies - start-up businesses that have the potential to develop an innovative product/service for sale in international markets.
  • Established manufacturing and internationally traded services companies that are SMEs.
  • Ambitious companies with the ability to scale and achieve significant success.

EI do not work with locally traded service companies or with micro-enterprises such as sole traders. EI's investment is in partnership with the promoters of

EI also provides a suite of grants from market research and internationalisation support, research and development supports, management team development, productivity supports and job expansion funds.

Ireland Strategic Investment Fund

In June 2013, the Government announced its decision to establish the ISIF and make the National Pensions Reserve Fund's (NPRF) €6.4bn of resources available for investment on a commercial basis to support economic activity and employment in Ireland. The NPRF committed €375m to three new long-term funds which will provide equity, credit and restructuring / recovery investment for Irish SMEs and mid- sized corporates.

Credit guarantee scheme

The credit guarantee scheme was launched in 2012 to facilitate the lending of €450m over a three year period. The scheme is targeted at commercially viable SME's which banks are unwilling to lend to. The facility amount under the scheme varies from €10,000 to €1m. 75% of the facility value is guaranteed by the state over a three year period. Businesses seeking to avail of the guarantee apply through one of the participating banks being Ulster bank, Bank of Ireland and Allied Irish Bank. The participating lenders review the credit application within their normal credit application procedures.

Microenterprise Loan Fund Scheme

This scheme was introduced in 2012 to facilitate €40m in lending over a five-year period with a provision for the scheme to be extended to provide a further €50m over a further five-year period. Loans of up to a maximum of €25,000 may be provided.

To be eligible for funding a business must

  • be a start-up or existing microenterprise (with turnover less than €2 million);
  • employ less than ten people; and
  • a request for credit must first have been declined by the banks.

DEFINED BENEFIT PENSION SCHEMES - HAS PRAY AND DELAY FAILED THE 'ROLLS ROYCE' OF THE PENSIONS INDUSTRY?

By Derek Ryan

The Pensions Board states in its own annual report that some 75% of all defined benefit (DB) schemes are in deficit and in many cases the deficit is substantial.

Under the Pensions Act, where a DB scheme falls into deficit and fails the statutory funding standard, they are obliged to submit a funding proposal to the Pensions Board showing how they intend to get the fund back by the next actuarial valuation. Since the funding standard was introduced by the Pensions Act, the three-year deadline to restore a scheme to solvency has been extended to ten years, following lobbying by the industry as a result of dips in the investment market. So how likely is it that these schemes will be able to pay the benefits that have been promised to the members?

It is well known that most companies have closed their DB schemes to new entrants and the trustees of the schemes still have a bias towards equities in their investment asset mix. It is therefore more likely that the funding position of these DB schemes will in fact deteriorate further rather than improve due to the following issues.

  • As the age profile of the scheme is increasing with more pensioners likely to join and new entrants prohibited from joining, the scheme liabilities will increase.
  • If it is decided to reduce the volatility of the investment return, and reduce the reliance on equities in the asset mix, the investment return assumptions used in the actuarial valuations will decrease, thereby increasing the liabilities and the deficit even further.

Deficits that currently exist in the DB schemes are not one-offs but are more likely to be a systemic deficit where the liabilities of the scheme are in effect pre-ordained to continue growing faster than its assets.

So if we now recognise that the deficits are indeed systemic and not temporary in DB schemes then the solution to these deficits will have to come from the Government, the employers and the scheme members themselves.

Various Government agencies involved in this area have introduced a number of solutions.

1. Section 50 of the Pensions Act allows deferred members' and pensioners' post-retirement increases to be reduced.

2. Post retirement increases for pensioners have been removed in the scheme wind up priority list.

3. Sovereign annuities were introduced. They are intended to offer trustees a lower cost option to secure pensioner liabilities by purchasing sovereign annuities. However, the regulatory authorities would only allow the assumption of sovereign annuities to be used if the scheme actually invested in these instruments rather than benchmark against them.

These Governmental solutions on their own are not going to make systemic deficits disappear overnight so the employer and the members can do a few things also.

1. Stop the clock now! The employer could decide to stop further accrual of benefit in the scheme immediately with future benefits likely to be provided under a separate DC scheme. This would have the effect of capping the employer's future pension liabilities. The DB scheme could either continue but only in respect of service already accrued to the 'stop date', or being wound up immediately. Employers need to be careful here because a scheme wound up now will throw up an immediate deficit and lead to active and deferred members getting a reduction in their accrued pension expectation. However, the employer could look at making a one-off large contribution to make up the deficit before wind up which has an attractiveness of a fixed defined cost.

2. Stop or reduce the deficit from growing by one or a combination of the following.

  • Reduce the rate of future accrual.
  • Reduce pension benefits already accrued for all or some members.
  • Revise the definition of final pensionable salary. Impose a cap on the level of earnings to €60,000 max.
  • Members make a contribution or an increased contribution if already contributing to the scheme.
  • Employer increases contributions to the scheme. The employer may well be at the limit as it is.
  • Ask senior executives (i.e. those with the largest liabilities) to transfer out to a Defined Contribution (DC) Scheme.

These proposals could be on future service benefits or on past and future benefits. If there is any reduction on benefits that have already accrued then the trustees need to undergo a procedure called a Section 50 /50a direction. This is where the trustees inform the Pensions Board that they need to reduce the scheme benefits as an alternative to winding up the scheme with a deficit.

DB schemes are likely to be in a systemic deficit which it is not realistically possible to deal with in any reasonable period of time or by assuming any reasonable set of future assumptions. The deficit is even likely to grow bigger over time. The reality is that many schemes have, in good faith, over-promised benefits relative to the scheme assets, the financial ability of the employer and the members to contribute to the scheme. The sooner this basic fact is recognised the better for all concerned, as the deadline to face up to this problem approaches.

The majority of DB schemes seem to be adopting the 'pray and delay' approach to the deficit problem, hoping that there will be a significant reduction in the funding standard and that equity markets will continue to recover to close the deficits in the schemes. That said, many of the DB schemes are winding up. In 2010, according to the Pensions Board annual report, 200 DB schemes were wound up. In addition, the Board also advised that in 2000 there were 1,956 DB schemes in operation. This was reduced to 1,013 by the end of December 2010.

Section 50 orders are small but increasing (according to the Pensions Board) where the employer is looking to decrease the benefits rather than wind up the scheme.

Finally, some of the senior executives who are members are looking to transfer out of the schemes to solidify their benefits and work towards a reasonable standard fund threshold of €2,300,000 under a DC scheme.

Many DB schemes are now winding up and stopping the continual increase in the deficits. This is drawing a line in the sand for the companies and gives some certainty to both employer and members alike.

DB schemes were the 'Rolls Royce' of benefits for employees many years ago and a privilege to be a member of, but perhaps now it's time that the car was exchanged for something a little more ordinary and a lot less expensive.

Footnote: Waterford Glass ECJ Judgement: The state may be partially liable for pension scheme deficits in DB schemes as a result of a recent ruling by the European Courts of Justice in April 2013. This judgement refers to DB schemes that are wound up as a result of the insolvency of the employer. Though we do not know the full implications on this decision as it has now been referred back to the High Court in Ireland, some may consider taking it into account if they are considering a transfer value from a DB scheme in deficit where the employer is also in financial difficulties.

MANAGING PERFORMANCE - TEN KEY QUESTIONS TO ASK YOUR FINANCE FUNCTION

By Manus Quinn

With the future of the global economy still uncertain, the management of financial performance remains more critical than ever. More and more owner/managers are looking at their finance function and asking whether it is delivering what is required.

Here we look at ten questions that owners should be asking of their finance function to assess whether the financial performance of the business is being maximised. They are not exhaustive and different businesses will have different requirements of their finance team, but all businesses will benefit from answering the questions below.

1. Does my finance function understand my business and the aspirations of the key stakeholders?

This is key. With the future uncertain it is important that the focus on long term strategies is not lost and that the key drivers for success, together with associated risks, are understood and monitored closely.

2. Is my finance function helping to drive the business forward?

Many finance functions report on a compliance basis, providing regular historical information to the stakeholders. However, the real value of a finance function is to be forward-looking and identify the opportunities for increasing the financial performance of a business, while minimising risk.

3. Am I being provided with relevant management information that helps make business decisions?

In the current environment many businesses have undertaken scenario planning. More than ever, management accounts with relevant key performance indicators (KPIs) and comparisons to key milestones must be produced on a timely basis along with forward-looking projections. These can be flexed to recognise current trading and various future scenarios.

4. Are the income streams sufficiently well understood to maximise pricing strategies?

For the vast majority of businesses, pricing is fundamental and the finance function should be at the heart of understanding customers' needs, the approach of competitors and the nature of the underlying market so that pricing can be set appropriately to attract sales but provide a sufficient return for the business.

5. Are business risks being minimised?

A strong finance function will assist and dire the business in identifying, documenting and developing plans to control and mitigate the key risks that the business faces.

6. Is my working capital requirement being managed?

With order books fluctuating violently in many sectors, the need to turn an order into cash as quickly as possible, and to manage the associated funding gap, is critical. Previous recessions have taught us that businesses face greater funding risks in the upturn than when the economy contracts in recession. Finance functions should therefore, as always, treat working capital and cash management as priorities.

7. Are the relationships with funders strong?

With the current level of uncertainty in the market it is important that businesses maintain a strong relationship with their funders, be they banks or equity providers, and ensure they are kept abreast of current and future developments in the company's activities.

8. Is the funding of my business appropriate and are the related risks being monitored?

Many businesses need flexibility in their borrowing needs, but at the moment banks are under pressure to reduce their exposure in certain sectors or types of funding. Businesses need to understand the risks associated with the different types of borrowing being offered. Invoice discounting may be appropriate in a buoyant market for a growing business, but how will the available facility be affected if turnover is reduced or customers extend their payment terms? Different banks have different risk profiles and so it is important that the finance team finds a lender who will provide the appropriate funding at the right price.

9. Are the overheads of my business appropriate?

Regular value for money audits and cost benefit analysis of overheads by the finance team will allow a business to negotiate terms with suppliers from a position of strength.

10 Are the relationships with professional advisers strong?

Is advice being sought to ensure that full advantage is being taken of tax breaks that are available for the business and are the full implications of investment strategies understood before decisions are made? Similarly, is the business aware of potential changes in financial reporting that may affect the way investors and lenders will look at the business in the future?

SUCCESSION PLANNING - NOW MAY BE THE TIME TO PASS ON BUSINESS ASSETS TO THE NEXT GENERATION

By Conor MacNamara

Succession planning essentially involves executing a strategy for business assets to be passed on to the next generation in an efficient manner. A number of factors, including taxation matters are generally crucial to an effective succession planning strategy.

The taxes that are normally required to be considered when business assets are transferred to the next generation are capital gains tax (CGT), capital acquisitions tax (CAT) which covers gift tax and inheritance tax, and stamp duty. A number of reliefs and exemptions from these taxes exist, the most significant being retirement relief for CGT purposes and business property relief for CAT purposes.

The 2009 Commission on Taxation Report recommended that retirement relief and business property relief should be significantly curtailed, among other changes to the Irish tax system. Bearing this in mind as well as the forthcoming Budget 2014, the possibility of further increases to the CGT and CAT rates (both currently 33%), the further lowering of the CAT exemption thresholds and the current depressed values of property, significant tax savings may be made by transferring assets to the next generation sooner rather than later.

An individual who transfers business assets should be regarded as making a sale for CGT purposes and should be liable to CGT on any gain arising. Where the assets are transferred to a connected party such as a family member, then market value should be imposed in calculating any gain arising.

Retirement relief for CGT purposes may be available provided that a number of conditions are satisfied. The main conditions are that the individual transferring the assets must be aged 55 years or more at the time of the transfer, the assets being transferred must be assets used in a trade or shares in a trading company/group and the assets must have been owned for at least ten years. If all of the conditions are satisfied, the relief is broadly calculated by reference to how much of the value of the assets being transferred is attributable to assets that are used for trading purposes.

The relief may apply in full if the qualifying assets are transferred to a child (or certain nephews/nieces) of the individual. Where qualifying assets are sold to a third party there is an absolute limit on the amount of retirement relief that may be claimed. With effect from 1 January 2014 the relief that can be claimed by an individual aged 66 or over will be curtailed. This will be the case in relation to transfers to a child or indeed to a third party.

The individual receiving the assets should be subject to CAT on the value of the assets received where the value exceeds a certain threshold. However, provided that a number of conditions are satisfied, business property relief may reduce the value of the assets for CAT purposes by up to 90%, effectively reducing the rate of CAT on these assets from 33% to 3.3%.

Where both CGT and CAT arise on the transfer of the assets, then any CGT paid by the individual making the transfer may be deducted as a credit against the CAT due by the recipient up to the amount of CAT due. This credit mechanism can significantly reduce the CAT liability.

Careful structuring may maximise these reliefs to the fullest extent. With the real possibility of these reliefs being significantly curtailed further in the not too distant future, now may be the time for many business owners to pass on business assets to the next generation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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