When your business is generating consistent profits, deciding what to do with surplus cash becomes a key consideration. Should you reinvest it into the business, extract it for personal use, or explore other options? 

For many companies, surplus funds are directed toward growth initiatives such as research and development, hiring, or expanding into new markets. Others may choose to extract the cash through bonuses, dividends, or pension contributions. But in some cases, withdrawing the funds may not be tax-efficient – or necessary for immediate business needs.

This opens the door to another possibility: investing surplus funds held on the balance sheet. With careful planning, these funds can provide an additional avenue for growth.

Assessing when to invest

The first step in deciding whether to invest surplus cash is ensuring your business retains enough liquidity for short-term obligations. Liquidity refers to readily available cash that can cover working capital, unforeseen expenses, or future projects. For example, funds set aside for known liabilities, such as tax bills, might be placed in fixed-term accounts to secure higher returns without concerns around accessibility.

Once your short-term needs are addressed, it’s worth exploring the options for extracting cash. Accountants and tax advisers can help you decide on a tax-efficient strategy, such as declaring dividends or bonuses to make use of personal tax allowances. Accountants can also work with a financial adviser to recommend a strategy of making pension contributions, which have the added benefit of being classed as a business expense, reducing the company’s Corporation Tax bill.

In some situations, it may make more sense to leave surplus funds in the business. For instance, business owners who have already used up their personal tax allowances or pension contribution limits may face high marginal tax rates if they withdraw additional funds. Additionally, family-run companies often use their shares as part of a succession plan, transferring ownership to younger generations over time. In such cases, leaving surplus funds in the business could support long-term planning objectives.

However, if funds are unlikely to be needed for at least five years, investing the cash may allow business owners to seek higher returns. While this approach carries more risk, it can be an effective way to make surplus capital work harder.

Building an investment portfolio for your business

If the decision is made to invest surplus funds, the business can establish an investment portfolio. Depending on the company’s appetite for risk, this portfolio might include a mix of shares, bonds, or other financial instruments. The business itself owns the portfolio, and the directors are responsible for agreeing on an appropriate investment strategy with a financial adviser. 

In some cases, creating a separate entity to hold these investments may offer additional benefits. Dividends paid between two limited companies are not taxable, which can make this structure advantageous. The trading company could pay a dividend to the newly established company and from there the funds would be invested.

Sometimes, the same objective of segregating the cash to be invested can be achieved by paying the dividend to a new or previously established holding company. If done correctly, this can protect the trading status and reliefs available to the trading company.

The process of establishing a new company to hold the investments will typically involve the redesignation of shares into different classes with income and capital rights. Obtaining good tax advice is crucial for the effectiveness of these strategies.

How are the investments taxed?

The taxation of corporate investments can be complex, and you should obtain professional tax advice. The accounting method being used will have implications for the taxation of the investments. 

While companies don’t benefit from the same tax-free allowances as individuals, there are advantages to consider. For example, dividends received by a company are tax-free, while capital gains and interest are subject to Corporation Tax. This makes dividend-focused investments particularly attractive for businesses seeking tax efficiency.

That said, it’s important to maintain a balanced perspective. It’s a common adage in our industry not to let the tax tail wag the investments dog. Tax considerations should not overshadow the primary goal of creating a diversified portfolio aligned with the company’s risk tolerance and financial objectives. Having said that, it may be appropriate to choose investments that are slightly more focused on generating dividends than out-and-out capital growth, given the preferential tax treatment of those dividends. 

Are there other implications for the business?

There are risks to holding cash or investments within a business. One critical consideration is the impact on Business Property Relief (BPR). BPR is a valuable relief that can exempt a trading company’s shares from either 100% or 50% of Inheritance Tax (IHT) when they are passed on. However, if a business holds significant cash or investments that aren’t being used for trading purposes, these may be classified as “excepted assets.” Excepted assets do not qualify for BPR, reducing the value of IHT relief available to the company.

In extreme cases, if non-trading assets such as investments or surplus cash dominate the company’s balance sheet, the entire business could be reclassified as an investment company rather than a trading company. This would mean losing BPR entirely, exposing the company’s shares to the full rate of IHT.

Deciding how to handle surplus cash is a pivotal moment for any business owner. Whether you choose to reinvest in growth, extract funds for personal use, or explore investment opportunities, each option should be guided by your long-term goals and a clear understanding of the financial and tax implications.

Investing surplus funds can offer significant benefits, however, it’s not a decision to take lightly. By working closely with your accountant, solicitor, and financial adviser, you can develop a strategy that balances liquidity, tax efficiency, and growth opportunities. With the right advice, surplus cash can become more than just a byproduct of success - it can be a catalyst for your company’s future.

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