As the owner-manager of a business, ensuring that your enterprise is profitable will always be a key goal. But once you’ve attained that goal of driving positive profits and have started to accumulate a healthy bank balance, what’s the most effective thing to do with this surplus cash?
Having excess cash in the business may seem like a good problem to have. However, if you’re going to utilise this excess in the most productive way, some serious thought needs to be put into your company structure, your tax planning and how you manage your own personal wealth planning as a company director.
Jon Chambers, Associate Tax Partner at Haines Watts North London, explains the importance of separating your trading and investment activities to get the best return from your surplus cash, whilst creating an optimal ‘lean and clean’ tax profile.
Knowing WHEN to begin planning for excess cash
Having plenty of cash sat in the business is an enviable position for an owner-manager to find themselves in. And when your cash on hand exceeds total company assets by more than 20%, that’s generally seen as being ‘excess cash’. This cash needs to be treated tax-efficiently if you’re to avoid losing a large chunk to HM Revenue & Customs (HMRC) on a future transaction.
But when should you start thinking about this kind of planning?
As a broad starting point, your company needs to be a £1M-£50M turnover business, with at least £1M in the bank, before it becomes beneficial to start thinking about setting up a new group structure and getting the relevant tax planning in place.
The potential benefit obviously has to factor in any advisor fees and other costs, so the size of that initial cash pot must be big enough to still deliver a healthy return after expenses.
So, if you fit the criteria, what are the first steps needed to maximise your cash?
The changing benefits of dividend payments
Awarding yourself a dividend payment used to be an attractive way to take money out of your business. But in 2016, HMRC brought in changes to the dividend rules to curb what it saw as excessive dividend planning.
The 2015/16 dividend allowance of £5,000 was slashed to £2,000, and the tax rates were increased for directors, making dividend payments a less attractive option for directors wanting to take surplus cash out of the business. It’s now become vital that directors manage their annual income to ensure they don’t tip over into a higher tax bracket.
At present the dividend tax bands are:
- 7.5% for basic rate taxpayers
- 32.5% for higher rate taxpayers
- 38.1% for additional rate taxpayers
The 2015/16 changes have made it necessary to look at alternative ways of utilising your excess cash, rather than simply paying out standard dividends. Proactive and detailed tax and wealth planning has become crucial.
To do this, it makes sense to set up a commercial investment vehicle so you aren’t leaking unnecessary cash.
Setting up a holding company
One option is to set up a new company to hold trading shares in your company and create a group structure – helping to create a more tax-efficient environment.
A holding company protects you from trading risks and creates a flexible corporate environment for your trading and investment activity. You will need HMRC clearance for this, as it’s a capital gains transaction and you could end up paying capital gains tax (CGT). This will involve disposing of the shares from the trading company, in exchange for shares in the holding company.
The next step is to set up a new subsidiary as a fresh company, next to the trading company. You can then invest excess cash into this subsidiary, although it’s worth noting that the subsidiary will have tax exposure to both CGT and inheritance tax (IHT).
De-merging your investment group
Another prudent step, once you’ve set up a sound corporate structure, is to look into de-merging the investment group.
When you de-merge, you take one company out of the group and into a new holding company. You’ll be running an investment business, in essence. Again, you’d need HMRC clearance to do this, but the benefits are definitely worthwhile.
By de-merging, you effectively create:
- One trading group – where all your operational activity takes place and the main trading finances are managed and held.
- One investment group – where your excess cash can be put to the best use and has the necessary structure and HMRC clearance to become tax efficient.
With this set-up, your whole structure is cleaned up, organised and tax-efficient. You now have a pot of cash within your investment company, enabling that cash to work for you and your business. The tax benefits of a demerger are that you end up with a clean trading company and a clean investment company, with the steps to get to this point all having been verified and cleared by HMRC.
Other tax-efficient routes for excess cash
With a clean corporate environment for your trading and investment activities, there are other additional planning routes you can take to ensure that your financial affairs are both productive and tax efficient.
Additional considerations may include:
Family investment company – setting up a family investment company (FIC) is an excellent way to pass wealth down from one generation to another, due to the potential IHT benefits. The makeup of an FIC differs vastly from situation to situation and there are numerous variations in the structure, ownership and assets – which is part of the appeal of setting up a customised FIC for your excess cash.
Entrepreneurs’ relief – if you own more than 5% of the shares in your trading company, you may qualify for entrepreneurs’ relief (ER) when you dispose of those shares. This reduces your capital gains tax bill down to 10% of the gain, which is not possible for shares in investment companies.
Substantial shareholding exemption – the substantial shareholding exemption is a corporate capital gains relief for the sale of trading subsidiaries and associated companies. With a clean corporate structure in place, if your new holding company holds at least 10% of the ordinary shares in the trading company, and has owned these for at least 12 months in the past six years, the disposal of the shares can be exempt from tax.
Business property relief – Business property relief (BPR) is an attractive tax relief if you have trading interests, offering either 50% or 100% relief from IHT on the value of your shares – if the right conditions are met.
Helping you make more of your money
Making the most of your excess cash isn’t as straightforward as simply leaving this money dormant in the company bank account. And I hope we’ve given you some practical ideas for getting proactive and making more from your surplus cash.
We specialise in providing tailored tax and wealth-planning advice for ambitious owner managers. Our tax specialists can help you:
- Review your current structure and financial position
- Set up a group structure and clean corporate environment
- Advise you on corporate tax-planning options and maximising your own personal wealth.
Talk to one of our Finchley Tax Advisors about planning for your excess cash.
Haines Watts is a firm of accountants in Finchley providing tax and business advice.