HMRC have given us an insight into how they would consider cash surpluses within a company following official responses to articles written on the subject.
On the death of a Shareholder, shares in a small or family trading company are usually considered to be business assets and hence not subject to Inheritance Tax, but if there is a large cash sum in the company then the shares may be treated differently.
For shares to qualify as a business asset for inheritance tax:
- They must be in an unquoted or AIM listed company,
- They must have been owned for 2 years,
- And at the date of death, the business must not consist wholly or mainly of the making or holding of investments.
There has in the past been little guidance on this last point but we do now have some.
Case law has suggested 25% of turnover is a good cash surplus to hold for business cash flow purposes.
HMRC have now adviced they are happy for larger cash surpluses to be kept as part of the business, but only if there is a business reason for retaining the cash.
Hence all cash held by the company needs to be justified as to the reason held. If that reason is not strictly business then the value of the business is split into surplus cash (with no business reason for being held), which is taxable, and the remaining business asset (including justified cash holdings), which is exempt from inheritance tax.
So if you have surplus cash then get your explanations in place e.g. keep records of your plans, and calculations as to why the business needs to keep that amount of cash.
Capital Gains Tax
If you sell or close your business then any profit on disposal is subject to Capital Gains Tax. Usual rates of Capital Gains Tax are 18% and 28% depending on whether the gains fall into your basic or higher rate tax band when added to your income.
However business gains may be eligible for Entrepreneurs Relief and hence tax at just 10%.
For shares to qualify as a business asset for Entrepreneurs Relief the shareholder must:
- Own at least 5% of the company and
- Have been a director or employee for the preceding 12 months.
- Additionally the company must contain less than 20% non-trading activities.
The third test here is as to activities so may be judged on time, turnover, expenses or history rather than just assets. HMRC have been calling this the Duck test – if it looks like a duck and quacks like a duck then it is a duck regardless i.e. if it looks like a business and behaves like a business then it is a business regardless of what it owns or has by way of cash surpluses or investments.
For Entrepreneur’s Relief the view of cash surpluses is hence very different. Surplus cash is not a problem as long as it is not an actively managed investment. If invested, then funds must be readily liquidated or will become an investment.
These features must be upheld until cessation of trade or sale of business