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Entreprenuers' Relief and cash-rich company

Scenario is a personal service company earns profits say £250K p/a (not in IR35). Director/shareholder only draws £50K p/a.

Over 5 years there is a substantial sum of cash left in the company bank account.

Will ER be available when the company is liquidated in 5 years time, or will its cash-rich status be a problem?

Thanks.

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I've been told

That this is not a problem for ER.

I'm not sure I agree, but this was a lecturer who told me from a well respect training company.

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Mmmm ...

But was he a well respected lecturer?

Let's see!  Another 5 years of £200K a year retained profits adds £1M to the existing "substantial sum of cash left in the company bank account".  That would presumably be nearly 100% of the assets of a personal service company and would certainly be unjustifiable in terms of working capital for a PSC.  And is he going to be content to leave £1M+ sitting in a deposit account earning minimal interest?  If he takes any positive steps to invest the money, even in something as simple as term deposits through his bank on the interbank market, he will be making an investment and will breach one of the main conditions for ER, even if the massive bank balance isn't enough to do that on its own.  You might get away with it, but income tax on £1M+, rather than CGT at 10%, is a massive difference which HMRC would want to collect.

If you are going to advise your client that it will be OK, make sure you have enough PII cover.

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Liquidation?

Will not a proper liquidation create a CGT situation otherwise wouldn't it be deemed income (post ESC C16)

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Liquidation

We were advised that no ER was available on this type of transaction when we were looking into doing it for a client in a similar situation. Advise came from the tax helpline that comes with our insurance, so not the revenue! 

 

 

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Thanks for all the comments.

Let's suppose this client does nothing with the cash funds, but merely leaves them on deposit. He trades full-time right upto the date of liquidation.

The retention of cash funds does not constitute an "activity" and the company is clearly trading.

Will ER not be due here? If not, where is the legislation to say so, please?

If all else fails, I'm assuming he'll be better off being taxed under CGT (via the liquidation), rather than IT, because of the lower tax rates (using today's rates).

Thanks.

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excerpt from CG64060 -

""However, the long term retention of significant earnings generated from trading activities may amount to an investment activity. The first point to consider is whether or not there is any identifiable activity distinct from the trading activity.

Factors to consider include:

whether the earnings are retained for the present and future cash flow requirements of the trading activity.the nature of the underlying investments used as a lodgement for the funds, for instance if the funds are locked into long term investments or the investments themselves are high risk that may suggest that they are not available for the trading activity.the extent of the company’s (or group’s) activity in managing the investments.whether the funds have been ear-marked for a particular use in the trading activity.

If a separate investment activity is identified then it will become necessary to determine whether that is substantial in terms of the overall activities."" '

If the sums involved are high you are unlikely to leave them on short term deposit and my understanding was that without demonstrable trading intentions in the future you would need to consider the substantial non-trading position

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mechanics of how the balance in company is taxed on winding up?

Assuming that the company did qualify for ER, can someone please give me a brief overview of how the cash left in the company (in excess of £25k) would be taxed on winding up?

Thanks.

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Also heard that it is not genarlly a problem (perhaps at the same lecture!)

 

you could consider getting HMRC clearance...

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distribution

the balance over £25k is a distribution and subject to higher rate tax hence very expensive and this one would require a formal liquidation to attract ER as a capital gain.

 

Going back to the availability of ER was there not a case that HMRC lost when it was held that if the cash arose from trading activties then no problem notwithstanding the amount ? Pretty sure I was told that a while back at a lecture. What is possibly more relevant is an attack under the transactions in securities rules that can be nasty although appearing to be very inconsistently policed by HMRC.

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your are looking forward

and the rules may well be tightened up following the case indicated by Pembo above.

How could the cash be used (invested in Gilts?) so that it becomes a trading activity with little or no risk is probally a question that you need to ask.

Based on the sums involved a winding up via a liquidator would seem to be the only way to get EP relief.  I am sure that you have though of transferring shares to the spouse and appointing her Co Sec to use up her nil rate band for CGT.

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I've had 3 similar situations in the last 18 months and on each occasion I have applied to HMRC for clearance. Each company had built up substantial cash reserves which it had retained in a current account. The last one had built up over £500,000 in a 2 year period. Each had ceased trading and had final accounts prepared. The first two were wound up under C16 and the third is currently in the hands of an Insolvency Practitioner.

With each letter requesting clearance I provided the latest balance sheet and a description of the companies activities. I pointed out the cash balance and highlighted it as a percentage of gross assets. I also stated the fact that there had been no active management of the cash balance as it had been left in a current account.

Clearance was granted in all 3 cases.

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