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Cash reserves, interest rates and taxation: Hold enough for business purposes but not too much
Whilst many business owners will recognise the importance of holding adequate cash reserves in a business, especially following difficult economic conditions such as those after the 2008 Financial Crisis, it is vital that they also recognise the potential issues with holding too much cash within a company.
The first and most obvious of these issues is, once again, linked to 2008. Business deposit accounts pay appalling rates of interest. Since the start of 2009 when interest rates were lowered to 0.5%, the cumulative return from a business account, after Corporation Tax, is around 6% whereas inflation over the same period has been 24.3%. That means that for every £100,000 of cash held on deposit, over £18,000 has been lost to inflation.
The second issue is less obvious but can be a significant problem in certain circumstances. HMRC accept that all businesses need to hold cash reserves but if these are seen to be out of proportion with the needs of the business, it is highly likely that the owners of the business will lose valuable tax benefits. This will be particularly problematic if the business is sold or wound-up or if one of the shareholders dies. In the first scenario, HMRC would argue that the Entrepreneur rate of Capital Gains Tax should not apply to the cash in the business. This would result in the value being taxed at 28% rather than then lower rate of 10%, which normally applies on the sale or wind-up of a trading company.
Excess cash may attract 40% Inheritance Tax
The second scenario can often lead to even higher tax charges applying. Most trading companies will qualify for Business Relief. This means that the value of any business held by the deceased is not subject to Inheritance Tax when they die. Where excess cash is identified, however, and HMRC do not accept it was required for the business to trade, this exemption is lost and Inheritance Tax of 40% would be applied. For family companies that have accrued significant levels of cash, this can result in a significant tax loss.
The key to maintaining the tax benefits whilst improving the return that can be generated from accumulated funds within a business, is to seek specialist independent financial advice. Jon Foster, a Partner of Independent Financial Solutions in Hampshire, has spent many years advising in this area. He comments: “We are able to offer businesses the ability to invest company funds in low risk, asset backed holdings, such as solar farms, asset backed lending and agricultural investments. These qualify for Business Relief, ensuring the Inheritance Tax position is secured and protects the CGT position if the business is sold or wound-up. On top of this, the annual returns are 6%, so much higher than cash. Interestingly, this approach can also be used, after the investments have been in place for a minimum of a year, by the shareholders to extract the funds with just a 10% tax charge whilst the original trading company continues to trade.”
If you would like further information on this subject, please contact us and we will be happy to talk to you and, if appropriate, to arrange a joint meeting with Jon Foster.