As businesses grow and expand, they can accrue an excessive amount of money that is not required for their day-to-day requirements. Whilst a good thing, business owners find there are often the same number of issues with having too much money as not enough.
Considerations Around Investing Cash
Maintaining surplus cash in an easy to access account can be the best option. It allows access as and when required. In these circumstances, the company’s bank account is likely to be the most suitable place to keep it.
However, there are circumstances in which a company has surplus funds that it doesn’t want to pay dividends. It could also be the wrong time to reinvest in the business.
Investment Options
Business owners are sometimes surprised to learn they can invest the company’s money into comparable investments to those they might undertake personally, e.g., bonds and unit trusts. The company could invest the excess funds to yield an improved return than that attained from a bank account. This could mean, for example, investments in stocks and shares. There are several approaches to investment. How these should be arranged is a matter of what is best for the business at the time.
A common approach for this type of investment is a company-owned life assurance contract which can hold investments or a company owned capital redemption bond. A capital redemption contract is one which, in return for one or more fixed payments, a sum or series of sums of a specified amount (based on actuarial calculations) become(s) payable at a stated time. However, assuming a capital redemption investment or life assurance investment is suitable, there are other factors to consider.
Applicable Taxes
If the business is in the UK, it should pay corporation tax on all its profits regardless of where those profits come from (whether they are paid in or sent to the UK). The business’s corporation tax bill is paid on profits (income or capital gains) which arise in each company’s financial year, with the current rate set at 19%, due to increase to 25% from April 2023.
Accounting Treatments
Another issue is the varying treatment of certain investments which is based upon the size of the business and even the type of accounting applied to the business. Since 2008, corporate investments using “Life Insurance Contracts” to invest have been treated differently depending on which accounting practice they use.
Companies using “Historic Cost Accounting” are taxed on profits made when they happen through encashment of part or all the investment due to the director’s own wishes, transfers to others (assignments) or death of the last life assured.
Companies using “Fair Value Accounting” will be taxable in the same way on any realised profits as above but also in addition on any increase in value of the Life Policy investment each year.
Over the life of a Life Insurance Investment, the business will have to pay tax on the actual profit it has made regardless of the accounting basis used. The timings and amounts of when taxes need to be paid will vary. Generally, what are known as micro-entities (turnover not more than £632,000, balance sheet not more than £316,000, average number of employees are not more than 10) will be able to use historic cost accounting; other companies must use fair value accounting.
This difference in treatment means that many businesses may need to pay taxes each year on any uplift in the value of investments. Even if these have not yet been realised if they are operating on a fair value accounting basis.
Business Relief
Business Relief (BR) exempts certain business assets (either 50% or 100% of the asset value) from inheritance taxes on death for those who are business owners. This exemption is valid on those assets which are required for the business to trade. In addition, it won’t be allowed if the business purpose consists of:
- wholly or mainly of dealing in stocks and shares;
- dealing in the making or holding of investments;
- or dealing in land or buildings (e.g. buy to lets, investment properties).
Worryingly cash can be as much an ‘excepted asset’ (as an asset which is not immediately required for the business) as any other investment. The exemption is only ‘checked’ on a transfer, including a transfer on death. It means that many businesses have a problem but might fail to realise its severity unless something happens. Keeping the business capital in cash rather than choosing to invest doesn’t solve the problem.
HMRC has stated that their rules apply even if you are holding more cash to weather potential difficulties. This could result in businesses retaining more cash than they require to operate, resulting in a larger tax bill on the death of a shareholder!
Business Assets Disposal Relief
Could investing in capital redemption investment or a life assurance change the position if some or the whole of the business is sold? Subject to meeting strict conditions, Business Assets Disposal Relief is allowed but only in respect of capital gains realised on the sale of any assets in the business. This is a 10% tax rate on the first £1m on gains.
These ‘business assets’ could be classified as the sale of shares in a company that is a trading company or a holding company of a trading group. However, this is only offered if the sale satisfies certain conditions. A trading company is defined as one that carries out trading activities and does not carry out other activities to a substantial extent. In the opinion of HMRC, ‘substantial’ in this context means more than 20%.
The activities test is very wide and includes:
- the company’s asset base,
- the company expenses incurred,
- income from non-trading activities and
- time spent by officers/employees of the company in undertaking its activities.
The “tests” above are not individual tests to which a 20% ‘limit’ applies but should be applied ‘in the round’ of the overall business position.
For example, holding an investment that is below 20% of the asset base may seem conclusive in terms of passing the “tests”. However, the associated relief may still be lost if the other criteria and activities of the business do not also meet the test limits.
The ideal initial step when considering what to do with surplus cash should be to have a conversation with a financial adviser. They help businesses to figure out how to invest the money and evaluate what level of risk is required. It is also vital to understand what investment vehicle it is placed in and the resulting impact.
If you believe any of the above affects you and would like to hear more about how we can add value for you and your business, please contact Paul Howorth, Financial Planner at Menzies Wealth Management on [email protected].
Menzies is a top 20 leading firm of accountants, finance and business advisors that operate out of a network of offices across Surrey, Hampshire and London, providing our clients with easy access and local knowledge. Described as the ‘best performing firm outside of the top 10’ by Accountancy Magazine, Menzies has over 400 employees and an annual turnover of more than £40m.
