Mark McLaughlin looks at an inheritance tax business property relief anti-avoidance rule that can result in a relief restriction.
Business property relief (BPR) offers inheritance tax (IHT) relief of 100% or 50% on a transfer of value attributable to ‘relevant business property’.
For example, unquoted company shares potentially qualify for 100% BPR, subject to certain general restrictions where the company’s activities consist wholly or mainly of dealing in stocks or shares, land or buildings, or making or holding investments.
The small print
There are certain conditions to secure BPR. In addition, there are anti-avoidance rules to prevent the relief being abused, including the ‘excepted assets’ rule (IHTA 1984, s 112). If ‘caught’ by this rule, BPR is restricted by the value attributable to the excepted assets, and an IHT liability can therefore arise.
There are two alternative tests. An asset is an ‘excepted asset’: firstly, if it was not used wholly or mainly for business purposes throughout the whole or the last two years of ownership ending with the transfer on which BPR is being claimed (i.e., the ‘past use’ test); or secondly, if it was not required for future use in the business (i.e., the ‘future use’ test).
‘Surplus’ cash?
Suppose that a family trading company has a large cash balance in its bank account. What can be done in practice to demonstrate that the cash is not ‘surplus’ for excepted asset purposes?
It is a question of fact whether the excepted asset tests are satisfied. The type of questions that HM Revenue and Customs (HMRC) might ask are listed in its Shares and Assets Valuation manual (at SVM111220). These are:
- 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?
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Does the amount of cash fluctuate?
Of course, every trading company needs working capital. How much working capital it needs will depend on the type of trade.
For example, in Barclays Bank Trust Co v IRC [1998] STC (SCD) 125, HMRC accepted that the company needed cash of around £150,000 (out of £450,000) for its trade, which represented about 25% of the company's turnover. Of course, every company is different; in practice, each company’s cash requirements must be considered on its merits.
What can be done?
If a trading company does have a large cash balance which appears to be surplus, what can be done to potentially improve the IHT position? Action points to consider might include:
- Using some of that cash for a business purpose (e.g., paying trade creditors, or discharging other business creditors such as hire purchase liabilities).
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Investing surplus cash in such a way that the company’s investment activities amount to a separate business (e.g., buying and managing some investment properties). The excepted assets rules do not apply to an investment business, so there should be no BPR restriction in respect of the company's shares on that basis.
Practical tip
If cash is invested into a company’s investment business activities, it is vitally important that those activities remain secondary to the company’s trading activities. This is because 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)).
