Surplus cash in a trading company is not always a good thing! Its existence can impact upon the availability of Business Property Relief (‘BPR’), a key form of IHT relief. BPR is a generous relief which can fully shelter unquoted company shares from the 40% inheritance tax net.
Entrepreneurs who have built up successful trading companies might reasonably expect to benefit from BPR so that they can pass down their business legacy to the next generation free from any IHT burden.
However, BPR does not apply to ‘excepted assets’, broadly, those assets which have not been used wholly or mainly for business purposes for two years or assets which are not required for future use in the business. Where a trading company has substantial accumulated profits in excess of its working capital requirements, BPR can therefore be restricted, with the surplus cash potentially being carved out for BPR purposes and subject to IHT at a rate of 40%.
The most straight forward option is to use the surplus cash for a trading purpose, such as acquiring P&M for use in the trade or repaying creditors.
The excepted assets rules do not apply to an investment business. On this basis, the company could invest its surplus cash, (thereby undertaking investment business), for example, buying and managing some investment properties.
However, it would be critical that the investment business is secondary to the main trading business, constituting less than 50% of the overall business activity of the company, otherwise BPR could be lost completely.
If the trading company invests the cash directly, this could also impact the availability of Entrepreneurs’ Relief, which has an even more stringent test – the investment activity would need to constitute less than 20% of the overall business activity of the company in order to qualify.
Hence, this option would probably only be appropriate for shareholders who have no inclination to sell the business and, rather, are purely focussing on achieving IHT efficiency.
Eventually if these strategies are taken to the extreme there will be a tipping point whereby investment activities will outweigh trading activities and, therefore, all BPR relief will be in jeopardy. At this point alternative strategies would need to be considered such as cash extraction or, alternatively, some kind of demerger whereby trading activities are separated from non-trading activities. As the main point of relevance for BPR is the occasion of death of a shareholder, it is unfortunately something that needs to be constantly monitored!
If you or your clients own a business that has generated surplus cash and wish to consider the available tax efficient options, please do not hesitate to get in touch.
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