If your client owns a family company, why should there be any concern about Inheritance Tax? Surely Business Property Relief will apply, and therefore there will be no Inheritance Tax?
Firstly, of course, you need to determine whether or not the company will be treated as a trading business for Inheritance Tax purposes. If it is an investment business, then Business Property Relief will not apply. This means, for example, that if your client’s business is property rental it will not attract Business Property Relief and, unless it is passed to the spouse or falls fully within the Nil Rate Band, it will attract 40% Inheritance Tax on your client’s death.
Assuming the company is a trading business for Inheritance Tax purposes, there may still be some Inheritance Tax to be paid. The reason for this is what is called “excepted assets”. These are assets which are not used for the purpose of the business. Perhaps the most common excepted asset is cash. Not all the cash in the company. Just the excess which it is not necessary to keep in the company. It is therefore important that if your client has significant cash reserves in the company those reserves can be justified for business purposes.
HMRC may look at the “typical” cash balance in similar companies of a similar size, and argue that if the cash balance is above this then the excess should be regarded as an excepted asset. It would therefore be a good idea for your client to establish what might be a typical cash balance. If there is a higher balance than this in the company then some work should be done to establish why this is necessary. Ideally a note should be made about this in the minutes of a Directors meeting.
One reason for keeping a higher than normal cash balance could be an intention to purchase capital equipment in the near future. Again, a note in the minutes of a Directors meeting would establish this, and that should be enough to thwart an attempt by HMRC to categorize some of the cash balance as an excepted asset.
What can your client do if it is clear there is too high a cash balance in the company?
One obvious strategy is simply to remove the cash through a dividend or bonus payment. This strategy, though, will have Income Tax consequences which your client may not wish to accept. They may well be happier for their beneficiaries to pay Inheritance Tax at some point in the future than personally to have to pay Income Tax now!
Another strategy can, however, be adopted in order to shelter the excess cash from both Inheritance Tax and Income Tax. The strategy is very simple. Just invest the excess cash! There will be more on this strategy in our next article.