It is not uncommon to come across successful companies with large bank balances. If the owners do not have any immediate use for the money they will avoid paying income tax of between 25% and 32% on dividend and simply leave the money in the company. Sounds a good plan but our advice is always to hold sufficient money in the company to support working capital and do something with the rest. This blog gives you three compelling reasons not to hold more cash than you need in your limited company.
High cash balances make you a target for litigation
Any asset held within the business is subject to business risk and can be lost on liquidation or an unforeseen business event that costs the company money. Another way to look at this is by holding surplus funds in the company you negate part of the benefit of limited liability. The point is surplus cash is not really a business asset and so should be protected by withdrawal. HMRC also think so as explained below.
Surplus cash is not a business asset for entrepreneur’s relief purposes
The implication of this is that should you sell your business and expect to obtain Entrepreneurs Relief on the sale of shares the surplus cash element will not qualify. If surplus cash is £500,000 the tax effect is an additional tax on sale of 28% - 10% being 18%. On our £500,000 example above this will cost the individual an additional £90,000 in tax.
Surplus cash is not a business asset for business property relief (BPR) purposes
This means that if you own a trading company and so expect your company shares to qualify for BPR then the value of the shares does not suffer 40% Inheritance Tax if you die whilst still holding them. However, surplus cash does not qualify, hence the Inheritance Tax charge on the £500,000 surplus cash would be £200,000 paid unnecessarily.
If you are worried about litigation you should extract the money from the company tax efficiently. My earlier blogs on EIS, VCT and pension explain this in more detail.
However, if you are quite happy to keep the money in the company the simple solution is to invest the surplus money in a low risk investment that does qualify for Entrepreneurs Relief and Business Property Relief. Such investments will typically provide a return above the cash return and remove the problems discussed above.
Chartered Accountant and Chartered Financial Planner