Last week I was looking at the subject of business relief for inheritance tax and how it can be completely denied if a company is not wholly or mainly a trading company.
So what amounts to “wholly or mainly” for this purpose? Well, it is generally taken as meaning more than 50 per cent. It seems the courts have tended to adopt a reasonably flexible approach in their application of this test to particular businesses.
Take the Brander case. It involved a large estate in Scotland, which consisted of a mix of occupied farms (run on a contract farming basis), farms let on agricultural tenancies and a number of houses and cottages mainly let on short-term tenancies. There were also sporting rights and parks let on a seasonal basis.
The two occupied farms (trading) represented about 35 per cent of the estate, whereas the let farms and other investment activities made up the balance. HM Revenue & Custom’s argument was that the estate should be denied business relief completely since it consisted “mainly of holding or making investments”.
In reaching its decision, the Upper Tribunal analysed various key factors stressing it was vital to look at the overall context of the business, with no one factor being conclusive. It was essential, they said, to consider all of the relevant factors in the round over a period of time so as to form a view about the relative importance of the investment and the “non-investment” activities to the business as a whole.
On this basis, the Upper Tribunal concluded that the estate’s business was mainly a “trading” one with business relief being available in full. This decision is particularly helpful as a reinforcement of the importance of taking everything into account when making a decision.
As I made clear in an earlier article in this series, in relation to cash held in the business it is the “excepted assets” test that is pivotal. For the purpose of this test, how the cash was acquired is not material. In many cases it will have been acquired through successful trading and will probably be resting in some current or business reserve account. Some businesses, given current low interest rates, may have made the decision to invest.
The excepted assets test is not just related to cash; it is relevant in relation to any asset that is not being used or being planned to be used for a business purpose. Separately, investing the cash could also give rise to other issues, namely potential denial of capital gains tax, entrepreneurs’ relief and/or a need to consider the loan relationship rules. I will consider the investment of corporate funds in future articles. It does not come up that often but when it does the sums involved are usually material.
So, the excepted assets test. How does it work and what is its impact? Well, as I have said, to the extent you fail the test you will proportionately deny business relief on the shareholding in the company in question. To get to this point, though, the company will have satisfied the wholly or mainly (trading) test described in detail earlier.
It is interesting to note that among all this subjectivity and apparent complexity HMRC operates a non-statutory clearance system to confirm whether business relief would be available for a proposed transaction or chargeable IHT event, such as a planned transfer of shares to a discretionary trust. This facility is only available where there is a material uncertainty over the application of the business relief legislation.
If the relevant matter concerns legislation that is older than the last four Finance Acts, it must relate to a commercially significant issue. Furthermore, HMRC will not deal with clearance requests for hypothetical cases or where there is no potential IHT liability in point (for example, due to the availability of the nil rate band).
The non-statutory clearance regime enables some certainty to be obtained on the business relief status of shares and so on, before a relevant transaction is undertaken or chargeable event occurs. Clearance applications should be carefully drafted and include all relevant facts and statutory and case law authorities.
So, in conclusion, high levels of corporate cash not specifically designated for business use can really affect the availability of business relief, as well as the proportion of the value of a shareholding in a company that qualifies for relief. Advisers should be fully aware of these rules and potential pitfalls. I will look at the impact of corporate cash on entrepreneurs’ relief next week.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn