There is no disputing cash is king. It is the oil that makes a business’ engine function. But having lots of cash can also bring some tax risks. And not the sort that would usually spring to mind for most SME owners.
The two I am referring to are the risk to business relief for inheritance tax and the risk to entrepreneurs’ relief in connection with capital gains tax.
Let’s consider business relief (still often referred to as business property relief) first.
The inheritance trap
IHT is likely to be the last tax on the minds of most business owners. Corporation tax, income tax, National Insurance, VAT: absolutely. But not IHT. Especially as some business owners will have a vague recollection that IHT does not apply to shares in a trading company. Are they not exempt? Well, yes they are, provided you satisfy the relevant conditions.
One-hundred per cent business relief is available for shares that have been owned in an unquoted trading company for at least two years. But you need to give the conditions a little more thought before consigning your business interest to the “no IHT due” box.
IHT is likely to be the last tax on the minds of most business owners.
So, what effect can excess cash have? In the worst case scenario, it can affect trading company status and deny 100 per cent business relief. Even assuming this complete denial is avoided, it can affect the proportion of the value of a holding in a company that qualifies for it.
Which assets count?
Under the “excepted assets” test, business relief is reduced to the extent the value of the shares reflects any excepted assets held by the business.
This anti-avoidance provision seeks to prevent taxable personal assets being sheltered from IHT by being held within a business relief eligible company. This might include holiday villas and other private assets held within the company for the owner-manager’s use, for example. The excepted assets restriction can also prevent business relief being given on excess cash reserves built up within a firm.
An asset is treated as an excepted asset if it was not used wholly or mainly for business purposes in the previous two years, unless it is required for future use in the business (IHTA 1984, s112(2)).
In order to decide this point, HM Revenue & Customs will generally seek to examine the accounts and other relevant business documentation at the time of death/chargeable transfer. It will look at substantial cash balances to determine whether they are really required for future business use.
Of course, there will be seasonal trades that generate a large cash balance at particular times of the year. In such cases, it should be possible to show that the cash was required to meet significant expenditure (on re-stocking, for example) after the date of death.
Hitting the buffers
In tough times, some businesses decide to retain chunky cash balances to act as a buffer in case things take a turn for the worse. Perhaps this is the case for many now in anticipation of Brexit.
A lot would argue that these amounts should be considered as legitimately held for business purposes. However, HMRC recently confirmed that, unless there is evidence showing the cash is being held for a specific identifiable future purpose, it is likely to be treated as an excepted asset.
It says holding a “surplus cash buffer to weather economic difficulties is not sufficient reason” to prevent the funds being treated as an excepted asset.
Given the importance of this point it is highly advisable to retain evidence of directors’ decisions and the like, as they will be crucial in rebutting any challenge in this area.
Having considered the excepted assets limitation, next week I will look at what I like to call the “small faces” test – the all or nothing test for business relief that the trading criteria compels us to consider.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn