Excepted Assets and Business Property Relief: s112 IHTA 1984 Explained

Surplus cash and bank deposits

Cash held in a business bank account beyond what is reasonably required for the day-to-day operational needs of the business is an excepted asset. HMRC assesses what level of cash a business of this type, scale, and sector would reasonably hold as working capital. Amounts above this level are treated as surplus and excluded from BPR. A business with £500,000 in bank deposits that only needs £50,000 for working capital may find that £450,000 is treated as an excepted asset — reducing BPR accordingly.

Planning: Deploy excess cash in the business (e.g. capital expenditure, prepayments) or extract it as dividends before death. Document the business case for holding any cash balance above normal working capital levels.

Investment properties not used in the business

Where a company or partnership holds investment properties (let to third parties, not used in the trade), those properties are treated as excepted assets — or, depending on the overall composition of the business, they may cause the entire business to fail the 'wholly or mainly trading' test, disqualifying BPR altogether. A trading company that also owns a portfolio of rental properties faces a double risk: the rental properties are excepted assets AND they may push the business over the threshold into investment company status.

Planning: Hold investment properties in a separate structure (e.g. a separate LLP or company) outside the BPR-qualifying trading entity. Ensure the trading entity is demonstrably 'wholly or mainly' trading rather than investment.

Non-business use assets (personal assets held in the company)

Assets held by the business but used for personal rather than business purposes — e.g. a boat, holiday home, or personal car owned by the company — are excepted assets. Even if the company owns these assets as investments, they are not 'required for the purposes of the business' and are excluded from BPR.

Planning: Extract personal-use assets from the business before death, or ensure they are genuinely used for business purposes with proper documentation.

Shares, bonds, and quoted investments

A trading company or partnership that holds a significant portfolio of shares or bonds as investments (not as part of its trading activity) will find those investments treated as excepted assets. This is separate from the wholly-or-mainly test — even if the business passes that test, the investment portfolio is still excluded from the BPR-qualifying value.

Planning: Review the investment portfolio held within the business. Consider whether it should be distributed to shareholders or restructured into a separate holding vehicle.

What are 'excepted assets' for BPR purposes?

Excepted assets are defined in s112 IHTA 1984 as assets that are: (a) not used wholly or mainly for the purposes of the business throughout the 2 years immediately before the transfer; or (b) not required at the time of the transfer for future use for those purposes. Only assets that satisfy one of the two positive tests — currently used in the business, or demonstrably required for the business in the future — qualify for BPR. Everything else is an excepted asset and is excluded from the BPR calculation. The BPR applies only to the 'net value' of the business, reduced by the value of excepted assets. So if a business is worth £2,000,000 but £500,000 of that consists of excepted assets, BPR at 100% applies only to £1,500,000 — saving £600,000 in IHT rather than the £800,000 that would have been saved without the excepted asset reduction.

How does HMRC apply the 'required for the purposes of the business' test?

HMRC's test is objective and fact-specific. 'Required for the purposes of the business' means that there must be a genuine and demonstrable business need for the asset at the time of the transfer (or in the preceding 2 years). Merely holding an asset within the business structure does not mean it is required for business purposes. HMRC considers: (1) what the business actually does — its trading activities; (2) whether the asset is actually used in those activities; (3) whether a business of this type and scale would genuinely need assets of this kind and quantity. HMRC applies the test with particular rigour to cash balances — a business with year-on-year growing cash but no plans to invest it is likely to have most of that cash treated as excepted. HMRC's IHT Manual at IHTM25265 et seq sets out their approach.

Can future business plans justify retaining cash as a non-excepted asset?

Yes — but the plans must be genuine, documented, and credible at the date of death. Cash held for a specific upcoming capital expenditure (e.g. new machinery ordered but not yet paid for, a planned acquisition for which heads of terms have been signed, or a lease renewal requiring a premium) can be treated as 'required for future use' and therefore not excepted. However, vague aspirations or undocumented plans carry little weight with HMRC. The stronger the paper trail — board minutes approving the expenditure, supplier quotes, legal agreements — the more likely HMRC is to accept the cash as required for the business. A general 'reserve fund' without a specific identified purpose is likely to be treated as excepted.

Does the excepted assets test apply to unincorporated businesses and partnerships?

Yes — s112 IHTA 1984 applies to BPR claims on businesses generally, not just on shares in companies. For a sole trader, the excepted assets test is applied to the business assets as a whole. For a partnership or LLP, the test is applied to the partnership's assets. In a partnership, each partner's interest includes a proportionate share of the partnership's assets — including any excepted assets. The BPR deduction for excepted assets is calculated in proportion to the partner's interest. A partnership with a large cash balance or investment property portfolio will face the same excepted asset reduction as a company.

What are the key strategies for minimising excepted assets before death?

The main planning strategies are: (1) Extract excess cash — pay dividends to shareholders, repay directors' loans, or return capital to partners to reduce surplus cash before death. (2) Deploy cash on genuine capital expenditure — invest in plant, equipment, property improvements, or inventory actually needed by the business. (3) Restructure the business — separate the trading and investment activities into different entities so the trading entity does not hold investment assets. (4) Document business purpose — maintain board minutes and business plans that evidence why any cash or investment asset is held and what it will be used for. (5) Seek a business valuation — understand the current BPR position (including excepted assets) well before death, so there is time to take corrective action. These are pre-death planning measures; restructuring after death does not cure excepted asset issues.

What happens if the excepted assets cause the BPR to be reduced significantly?

Where excepted assets represent a large proportion of the business value, the IHT saving from BPR may be substantially lower than expected. For example: a business worth £3m with £1m of excepted assets (surplus cash and investment property). BPR applies only to the £2m of qualifying business assets: saving £800,000 in IHT (at 40%). Without the excepted asset adjustment, BPR on the full £3m would have saved £1.2m. The excepted asset reduction costs the estate £400,000 in additional IHT. In extreme cases, if the business is predominantly investment (failing the wholly-or-mainly test), BPR is denied entirely on all the shares — not just the investment portion. Business owners should obtain a specialist IHT and BPR review well in advance of any anticipated transfer.