Business property relief (BPR) is a valuable form of inheritance tax (IHT) relief. It applies to various types of ‘relevant business property’, including shares in an unquoted company. Perhaps unsurprisingly, the relief is subject to various conditions, and there are anti-avoidance provisions which can restrict the amount of relief available in certain circumstances.
Shares in an unquoted company are not ‘relevant business property’ if the company wholly or mainly carries on certain excluded activities, i.e. dealing in securities, stocks or shares, land or buildings or making or holding investments (IHTA 1984, s 105(3)). These exclusions are subject to certain exceptions (in s 105(4), (4A)), including where the company’s business consists wholly or mainly in being a holding company of a group of companies whose business does not consist of excluded activities. However, this article focuses on single unquoted trading companies, which are not carrying on excluded activities.
The above ‘wholly or mainly’ requirement is an ‘all or nothing’ test. For example, shares in an unquoted company which is carrying on 51% trading activities and 49% investment business activities may qualify for BPR in full. Conversely, the company’s shares will be eligible for no BPR at all if its business activities are 49% trading and 51% investment.
Beware surplus cash
Anti-avoidance provisions apply to ‘excepted assets’ (IHTA 1984, s 112). The general rule is that an asset is an excepted asset if caught by either of two alternative tests. The first test is that the asset was not used wholly or mainly for the purposes of the business throughout the whole or the last two years of the relevant period. The second test is that the asset was not required for future use in the business. There is a relaxation of the excepted asset provisions in respect of group companies, but this article is concerned with a single trading company.
HMRC guidance explains that the purpose of the excepted assets provisions is to prevent taxpayers from getting the benefit of BPR for private assets, by confining the relief to those assets needed in the business. Broadly, it would be relatively easy to ensure that BPR became available on a non-business asset by placing it into a company business wrapper.
Example – Company ‘money box’
Alex is the sole shareholder of XYZ Ltd, a successful trading company. He has a substantial amount of cash in his private bank accounts. Alex is concerned about the potential IHT liability on those funds.
In the absence of the excepted asset provisions, Alex might try to secure BPR on his private cash funds by using the cash to subscribe for additional shares in XYZ Ltd. That cash may then be sitting in the company without it being needed or used in any business being carried on by the company.
Effectively, Alex would be treating XYZ Ltd as his personal ‘money box’, on the basis that the funds are sheltered from IHT, assuming that 100% BPR would otherwise be available on the company’s shares.
The excepted assets provisions are aimed at preventing BPR being exploited in such circumstances.
If ‘caught’ by the excepted asset provisions, the effect is broadly that BPR on a transfer of value (e.g. a lifetime transfer into a discretionary trust, or a deemed transfer on death) is restricted by the value attributable to the excepted assets. Only that part of a transfer of value which relates to ‘relevant business property’ is reduced by BPR; the other part relating to the excepted asset is not reduced by BPR, and is chargeable to IHT in the normal way.
It should be noted that excepted assets can take various forms (e.g. holiday homes, sports cars or luxury yachts). However, this article concerns perhaps the most common form of excepted asset held by unquoted trading companies – surplus cash.
HMRC accepts that a ‘hybrid’ (i.e. trading and investment) company that is mainly trading will not be subject to the excepted assets rule in respect of assets used in the investment element of the business. However, surplus cash is not regarded as a separate investment business, and HMRC will not treat it as part of the company’s hybrid business (see SVM111220).
Past or future use
As indicated above, surplus cash will normally be an excepted asset unless it meets a ‘past use’ or a ‘future use’ requirement in terms of business purposes.
(a) Past use
The first test (in IHTA 1984, s 112(2)(a)) broadly requires that the asset must have been wholly or mainly used for business purposes throughout the whole of the ‘relevant period’. This period is either the two years immediately preceding the transfer of value in question, or the whole period of ownership if less than two years.
For example, XYZ Ltd (see above) could use the additional cash from Alex’s share subscription to buy plant and machinery for use in its trade, even if the plant and machinery is bought shortly before a transfer of shares in the company on which BPR is claimed.
(b) Future use
The second test (in IHTA 1984, s 112(2)(b)) broadly means that the asset must have been required at the time of the transfer for future use in the business. This ‘future use’ test can cause difficulties in practice. For example, in a trading company with a large credit balance on its bank account, identifying how much (if any) of that cash balance is ‘surplus’ for this purpose can be problematic.
In Barclays Bank Trust Co Ltd v IRC [1998] STC (SCD) 125, the deceased held 50% of the shares in a company carrying on an old established trade of selling bathroom and kitchen fittings. It had a strong cash position. At the time of the deceased’s death, the company held over £450,000 in cash. The Inland Revenue (as it was then) accepted that £150,000 was needed by the company at that time, but maintained that the remaining £300,000 was an excepted asset. The Special Commissioner upheld the Revenue’s view, rejecting the argument that the cash was required for the future purposes of the businesses, and dismissed the appeal.
If cash has been earmarked for future business use, clear evidence should be maintained of its intended use (i.e. for a specified project or business purpose), which should be applied within a defined timescale.
Is it really surplus?
Whether cash is ‘surplus’ will depend on the particular facts and circumstances of the company. For example, virtually every trading company needs working capital. The Barclays Bank Trust case arguably provides a useful ‘rule of thumb’ as the undisputed amount of cash needed by the company represented roughly 25% of its turnover. If any of the remaining cash is surplus, the business may, for example, wish to consider applying all or part of those funds in paying trade creditors or discharging other liabilities of the business.
There may be other factors to consider. For example, seasonal businesses will often hold substantial cash at certain times of the year. In addition, the company may retain a higher proportion of funds during difficult trading conditions (not least due to the general reluctance of banks to provide working capital in some cases).
However, HMRC has stated that unless there is evidence that cash is held for an identifiable future purpose, it is likely that it will be treated as an excepted asset. Thus the holding of funds as an ‘excess buffer’ to weather an adverse economic climate is not considered by HMRC to be a sufficient reason for it not to be classed as an excepted asset (ICAEW Taxguide 1/14).
HMRC guidance (at SVM111220) outlines a series of questions to be considered in determining whether cash is in fact surplus and therefore an excepted asset:
- Was the cash used for the business?
- Was the cash used to finance the business carried on by the company?
- How much cash did the company use regularly?
- What were its short-term cash requirements?
- Does the amount of cash fluctuate?
Practical point
To the extent that the company’s cash is genuinely surplus, consideration could be given to applying the funds towards investment business activities. As indicated above, shares in a trading company with a secondary investment business may be eligible for BPR in full. However, it is extremely important not to breach the ‘wholly or mainly’ excluded activities test, by ensuring that the investment business activities do not predominate over its qualifying trading activities (see HMRC guidance at IHTM25263 and SVM111150). Otherwise, BPR may be lost entirely (IHTA 1984, s 105(3)). Expert professional advice should be sought on maximising BPR on the shares and preventing such pitfalls, if necessary.
The above article was first published by Tax Insider (May 2015) (www.taxinsider.co.uk).