As promised last week, I am going to look at some of what I believe to be frequently asked questions in relation to entrepreneurs’ relief. I am doing this because many clients of advisers considering the investment of corporate funds are unclear as to the basic rules, let alone planning opportunities.
With all this in mind, and with the benefit of a conversation with Peter Rayney of PR Tax Consulting (a recognised expert in this area and good friend to Technical Connection), we thought you might value the following set of frequently asked questions and (maybe not so frequently given) answers.
Q1: Does HM Revenue & Customs still, effectively, ignore cash held on deposit that had its source in trading profits when assessing the “not more than 20 per cent” of assets indicator for entrepreneurs’ relief?
This test is, of course, one of those that might be applied when seeking to ascertain that there is not a significant amount (20 per cent or more) “non-trading” activity). Has there been any recent change to this practice of ignoring “retained profits”?
A1: HMRC does seem to still ignore cash stemming directly from retained profits and, no, there has been no recent change in this HMRC approach.
In any case, there is a strong argument that simply retaining cash from trading cashflow is not an activity at all – and hence it cannot be a non-trading activity for entrepreneurs’ relief.
Q2: If that cash was taken off deposit and invested into, say a collective investment or insurance-based investment but was “disinvested” and left in cash for a year before the disposal for which entrepreneurs’ relief was claimed (so there will have been no “investment” within a year of sale), would entrepreneurs’ relief be at risk
● If the funds had their original source in retained profits?
● If the funds were never from retained profits but were nevertheless in cash for the whole of the 12 months before disposal of shares?
A2: If the funds had been actively invested, then this would be a non-trading activity. This action of investment could represent a risky strategy.
When the funds are liquidated back into cash, they would have lost their original “trading” status – since they would most proximately have resulted from the realisation of investments – despite their origination in trading profits.
Hence, there is a high risk that HMRC would regard them as non-trading and, depending on the 20 per cent test, this might prejudice entrepreneurs’ relief.
A similar analysis would, of course, arise for original “non-trading” source cash. On all these types of issue, though, as indicated in the HMRC manual , it will often be necessary to take into account a number of overall indicators to determine whether there is a substantial non-trading activity.
It is sensible practice to put the precise facts before HMRC before to an actual proposed sale via the informal business clearance procedure.
Entrepreneurs’ relief is a big deal for business owners. Ensuring that any risk to it is avoided is essential – especially when considering the potential investment of funds held on deposit that had their source in retained profits.
There is an understandable increase in appetite to accept a little more risk to secure a better return than interest on deposits.
However, aside from ensuring that the business’ need for working capital is taken into account and the business attitude to risk is factored in, there is also the sometimes forgotten need to ask the right questions in relation to entrepreneurs’ relief.
Even if a sale is not imminent, actively investing sums on deposit that came directly from retained trading profits could, as indicated above, contribute towards putting entrepreneurs’ relief at risk.