Too much of a good thing?

By | 12 April 2022

Business property relief (BPR) offers relief from inheritance tax (IHT) of 100% (or 50%) on a transfer of value which is attributable to ‘relevant business property’.

Unfortunately, not all unquoted company shares qualify for BPR. Certain company activities make the shares ineligible for relief, such as dealing in stocks or shares, land or buildings, or making or holding investments (IHTA 1984, s 105(3)). These exclusions are subject to only limited exceptions (in s 105(4), (4A)).

However, let us take the example of a single unquoted trading company, which is not carrying on an excluded activity.

Exception to the rule

Perhaps unsurprisingly, the BPR legislation includes an anti-avoidance provision in respect of ‘excepted assets’ (in IHTA 1984, s 112).

Without this anti-avoidance rule, a wealthy individual (for example) might try to secure BPR on his private cash funds by using the cash to subscribe for additional shares in the company. That cash may then be sitting in the company without being needed or used in any business being carried on by the company. Effectively, the individual would be treating the company as his personal ‘money box’, on the basis that the funds are sheltered from IHT (assuming 100% BPR is available on the company’s shares).

If ‘caught’ by the legislation, the transfer of value for BPR purposes is broadly restricted by the value attributable to the excepted asset.

Excepted assets can take various forms (e.g., holiday homes, sports cars, or luxury yachts). However, this article focuses on surplus cash in the company.

Is it caught?

The statutory definition of ‘excepted asset’ (in IHTA 1984, s 112(2)) provides that an asset is an excepted asset if it was neither used wholly or mainly for the purposes of the business throughout the whole or the last two years of the relevant period (‘past use’), nor required for future use in the business (‘future use’).

HMRC’s guidance (at IHTM25351) indicates that, in order not to be excepted, surplus cash must meet both the ‘past use’ and ‘future use’ requirements. However, HMRC’s view does not seem to accord with the legislation, which indicates that an asset only needs to meet one of those requirements.

The ‘past use’ test

As indicated, there are two separate tests to determine whether an asset is excepted. The ‘past use’ test looks at the whole or the last two years of the relevant period. The ‘relevant period’ for a single company is broadly the period immediately before the transfer of value during which the asset was owned by that company (IHTA 1984, s 112(5)).

The ‘past use’ test period may therefore be less than two years if the company has owned the asset for that shorter period. For example, a trading company with surplus cash could use some of that cash to purchase plant and machinery for use in its trade shortly before it becomes necessary to consider the availability of BPR (e.g., on the death of a shareholder).

The ‘future use’ test

HMRC’s view is that future use must clearly be contemplated, and that there should be evidence of some positive decision or firm intention. HMRC will also look at the nature and previous history of the company’s business.

In Brown’s Executors v IRC [1996] STC (SCD) 277, the deceased (B) died in November 1986. He was the majority shareholder in a company (‘Gaslight’) which had operated a nightclub. The nightclub was sold in January 1985, and the proceeds were paid into a short-term deposit account of Gaslight. Prior to his death, B looked at premises with a view to Gaslight opening another nightclub. Unfortunately, B died suddenly of a heart attack, without the company having opened another nightclub. The Inland Revenue (as it was then) rejected the BPR claim on B’s shares in Gaslight, not on the basis that the company’s proceeds from the nightclub sale was surplus cash and an excepted asset, but that Gaslight had become an investment company due to deposit account interest received. However, the Special Commissioner allowed the executors’ appeal; it was necessary to look at Gaslight’s operations in the two years prior to B’s death, as well as the directors’ intentions. Whilst this case did not specifically address the excepted assets rules, HMRC considers that the Special Commissioners’ comments are relevant to them (see HMRC’s Shares and Assets Valuation manual at SVM111230).

On the other hand, in Barclays Bank Trust Co Ltd v IRC [1998] STC (SCD) 125, the deceased held 50% of the shares in a company which had an old established business of selling bathroom and kitchen fittings. The company’s turnover fluctuated around £600,000, and it had a strong cash position. At the time of the deceased’s death, the company’s cash at bank was approximately £450,000. It was argued for the company that the cash held on the deceased’s death was required at that date for its future business use. The Revenue accepted that the company needed cash of around £150,000 but argued that the other £300,000 was an excepted asset. The Special Commissioner held on the evidence that the cash of £300,000 was not required for future use by the company in its business, and commented: “…‘required’ implies some imperative that the money will fall to be used upon a given project or for some palpable business purpose.”

What’s ‘surplus’?

It is a question of fact whether the excepted asset tests in IHTA 1984, s 112(2) are satisfied, and evidence is important. Questions that HMRC might ask are listed in its Shares and Assets Valuation manual (at SVM111220):

  • ‘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?’

Every trading company needs working capital. How much is needed will depend on the type of trade. HMRC’s guidance (at SVM111230) accepts that in difficult trading conditions such as a recession, the company may retain significant amounts of cash (e.g., where the company is currently making losses and the cash is needed to support its main trading activity). However, HMRC considers that the holding of funds as an ‘excess buffer’ to weather the economic climate is not a sufficient reason for it not to be classed as an excepted asset (ICAEW Technical Release 1/14, January 2014).

Practical points

If a trading company has a large balance of surplus cash, actions that might be considered to potentially improve the IHT position include:

  • using it for a business purpose (e.g., paying trade creditors earlier, or discharging other business creditors such as where the company has bought plant and machinery under a HP agreement and has an outstanding liability which could be repaid early without incurring a penalty).
  • investing the surplus cash in such a way that its investment activities amount to a separate business (e.g., by acquiring a portfolio of quoted shares and securities). The excepted assets rules do not apply to an investment business, so there should be no BPR restriction (see SVM111220). However, it is vitally important that the company’s investment activities remain secondary to its trading activities. If the investment business predominates, so that the company is wholly or mainly an investment company, BPR entitlement on the company’s shares will be lost completely (IHTA 1984, s 105(3)).

The above article was first published by Tax Insider Professional (