Investment Linked Repayment Option Liberty Investments
The doors we open and close each day decide the lives we live. Flora Whittemore
When medium term finance for business purposes is approved, selected bank clients may be offered a choice of payment methods: • to repay the loan in instalments over the period with each instalment comprising interest and a part repayment of capital, or • to repay only interest over the period with the capital being repaid in a lump sum at the end of the period. The Liberty Investments Investment Linked Repayment Option offers businesses the opportunity to repay the capital component of a bank loan through a Sinking Fund policy. Depending on the performance of the investment, the borrowing cost of the transaction may be reduced substantially.
The ABC of the Investment Linked Repayment Option A. Commencement of plan Takes loan from the bank
Business
Invests in a debt redemption plan
of a capital nature and is incurred in the production of income for the purpose of trade. Tax deductibility should be confirmed in the specific circumstances of each case.
B. During the loan repayment period Business Pays only interest due on loan
Pays premiums on plan
Bank
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Investment Linked Repayment Option
The total expenditure under the debt redemption plan is higher than if the loan was repaid to the bank because of the higher interest charge. The higher interest charge means greater tax deductions (provided the interest is deductible).
C. At the end of the loan repayment period
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Advantages of the Investment Linked Repayment Option •
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Business Sinking Fund investment policy collaterally ceded back to the bank
Bank
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Investment Linked Repayment Option
The likelihood of the plan being effective is greatly enhanced if the business is able to claim the interest payments as tax deductions. Generally, the deductions are allowed in terms of the Income Tax Act if the expense (the interest) is not
Bank cancels collateral cession of matured policy. Any surplus is available as a tax-free lump sum
Debt redemption plan matures; all tax due prepaid by insurer
Investment value paid to bank to repay loan
Bank
Investment Linked Repayment Option
At maturity, the company settles the loan. The loan agreement with the bank is terminated. The collateral cession is cancelled and unrestricted access reverts to the company; any surplus belongs to the company. The surplus can be used for future projects.
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Return on investment: Depending on the investment performance of the Sinking Fund policy, a business could receive a significant tax-free surplus amount after the capital portion of the loan has been settled with the bank. Bank guarantee: In the case of surrender due to the bank’s foreclosure of the loan, Liberty Investments will pay the bank the greater of the actual policy surrender value and the total premiums paid since inception. Guaranteed investment value: The policy is structured in such a way that the investment value is guaranteed to equal the original loan amount at the end of the policy term if all premiums are paid. The policy’s premiums are calculated according to the capital amount required at the option date. Tax rebates: As the business will be dividing the debt repayments into a fixed capital and an interest portion, the business will potentially qualify for a greater tax deduction (see Important considerations below).
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Portfolio diversification: The business can choose either one or a combination of guaranteed portfolios in which to invest. The following portfolios are currently available: Excelsior Managed, Excelsior CPI Plus, Excelsior Property and Excelsior Multi-manager CPI Plus. Policy bonus: As a reward for maintaining your policy with Liberty Investments, a 25% policy bonus will become payable at the end of the fifth policy anniversary. Ongoing management fee: Management fees are levied on the investment value and will reduce after five years and again after ten years for both recurring and single premiums: • first five years: 3% p.a. of investment value (levied monthly) • next five years: 2.25% p.a. of investment value (levied monthly) • thereafter: 1.75% p.a. of investment value (levied monthly).
Important considerations •
Tax implications: The Investment Linked Repayment Option is only effective if the business can claim the interest payments as tax deductions. To do so, the business must prove that the purpose of the loan was to provide the business with working capital. Example: The Investment Linked Repayment Option of a company that borrows money from the bank at 12.5% p.a. will need to yield 9% p.a. (after deduction of tax and product charges), provided that the company will be able to claim back tax deductions of the interest paid. This net rate is calculated as follows:
Required net rate = Borrowing rate x (1 – tax rate) = 12.5% x (1 – 28%) = 9% p.a. If the Investment Linked Repayment Option is structured correctly and consists of a bona fide loan agreement, a first-hand policy and a collateral cession, there will be no secondary capital gains tax implications. •
Policy performance: The investment return (after deduction of tax and product charges) achieved on the Investment Linked Repayment Option needs to exceed the required net rate as calculated above for the plan to be feasible. This rate is usually referred to as the break-even rate. This is the rate at which the cost of the Investment Linked Repayment Option equals the cost of normal loan financing. The time value of money should be taken into account to determine the effectiveness of the debt redemption plan.
Minimum premiums Companies would need to be able to afford the following minimum regular premiums: • monthly: R2 500 • quarterly: R7 500 • half-yearly: R15 000 • annually: R30 000.
Policy term The Investment Linked Repayment Option makes provision for a choice of policy terms ranging between five and 15 years to meet the need to have a guarantee apply at the end of the term of the loan. After the initial policy term the company can leave the policy in force with the option
of continuing premiums. This gives the company the easy access of a matured policy while potentially funding for other future expenses.
Ownership Only companies, including closed corporations, may own an Investment Linked Repayment Option.
Conclusion An Investment Linked Repayment Option has the potential to finance a capital loan in such a way that, after settling the loan, your business could receive a significant tax-free lump sum back. The surplus money can finance further operating capital or the purchase of new assets, thereby gearing your business for continued growth.
Lesoba Difference 10296 Jan 2010
LIBERTY INVESTMENTS Liberty Life Centre 1 Ameshoff Street Braamfontein Johannesburg 0860 456 789 www.liberty.co.za
The information contained in this document does not constitute advice by Liberty. Any legal, technical or product information contained in this document is subject to change from time to time. If there are any discrepancies between this document and the contractual terms or, where applicable, any fund rules, the latter will prevail. Past performance cannot be relied on as an indication of future performance. Investment performance will depend on the growth in the underlying assets, which will be influenced by inflation levels in the economy and prevailing market conditions. Any recommendations made must take into consideration your specific needs and unique circumstances. Liberty Group Ltd is an Authorised Financial Services Provider in terms of the FAIS Act (no. 2409). The Investment Linked Repayment Option is underwritten by Liberty Active Ltd, a wholly owned subsidiary of Liberty Group Ltd. © Liberty Group Ltd 2010. All rights reserved.
