Inheritance Tax on Business Assets: Navigating the BPR 'Wholly or Mainly Trading' Trap for UK Directors (2025/26 Guide)

Picture this: You’re the director of a successful UK-based limited company—perhaps a software firm, a manufacturing business, or a property management company. You've worked for years to build up its value, and you believe that, upon your death, your family will benefit from a massive, 100% relief from Inheritance Tax (IHT) on the company’s shares. This is the promise of **Business Property Relief (BPR)**, one of the most powerful and valuable reliefs in the UK tax system.

Here's the thing: BPR is not a blanket guarantee. While it can slash a 40% IHT bill to zero, its application is constantly scrutinized by HMRC. For directors and shareholders, the biggest hidden risk is the 'wholly or mainly trading' test. If your company holds too much in the way of "excepted assets"—things like cash reserves, investment properties, or surplus funds—your entire BPR claim can be invalidated. This single technicality has tripped up countless estates, turning an expected 100% relief into a full 40% IHT liability. If you're building a business legacy, understanding this trap is critical for your estate planning.

The 'Wholly or Mainly Trading' Principle: Explain the "Why"

To grasp BPR, we must first understand the fundamental policy behind it. BPR exists to allow the generational transfer of genuine, productive **businesses** without a prohibitive tax charge that could force the sale of the company and lead to job losses. It is not designed to protect passively held investments. Think of it as a reward for taking the entrepreneurial risk of trading.

The core legislation states that a business is eligible for 100% BPR (on unlisted shares) or 50% BPR (on assets used in a partnership or sole trade) only if it is not one that consists “wholly or mainly of dealing in securities, stocks or shares, land or buildings or making or holding investments” (IHTA 1984, S105). That crucial phrase, **'wholly or mainly'**, is the lynchpin, and HMRC interprets it as being more than 50% based on factors like turnover, capital employed, and time spent by employees.

Let's explore this using an analogy. Imagine your company is a two-wheeled vehicle. One wheel is the **Trading Wheel** (e.g., selling software, making goods, providing services), and the other is the **Investment Wheel** (e.g., collecting rent, earning passive interest, holding excess property). To qualify for 100% BPR, the Trading Wheel must be significantly larger than the Investment Wheel—it must be the 'wholly or mainly' driving force of the business. If the Investment Wheel becomes dominant, BPR is lost.

This matters because many successful businesses, especially in the UK’s buoyant digital sector, naturally accumulate cash. For example, a successful SaaS company with retained earnings of £2 million might leave £1.5 million sitting in a high-interest savings account. While this seems prudent, if that £1.5 million is not immediately needed for trading (such as R&D, salaries, or specific planned expansion), HMRC might deem it an **excepted asset**, and the whole company could fail the 'wholly or mainly trading' test. The result? That £2 million business value is suddenly taxed at 40% IHT.

Scenario-Based Breakdown: The "What"

To make sense of the real-world application, let’s break down four common scenarios UK limited company directors face. The table below shows exactly how the balance of trading vs. excepted assets impacts BPR eligibility.

HMRC often assesses the BPR test using a composite view of four metrics: the company's **turnover, asset base, expenses, and time spent** by employees. In practice, the asset base test (i.e., the ratio of trading assets to investment assets) is usually the most telling. The latest figures show that HMRC raised **£400 million** in additional IHT assessments between 2022/23 due to challenges on reliefs, a significant portion of which includes BPR claims that failed the trading test (HMRC Challenges to IHT Reliefs, 2024).

As you can see, the mere act of trading is not enough. The business must be demonstrably dominated by its trading activity. The grey area sits directly on the 'wholly or mainly' dividing line. If your company’s investment activities creep above 50%, you've failed. But even below 50%, the existence of large 'excepted assets'—like that £2 million surplus cash—can skew the capital test and lead to a total failure.

Excepted Assets and the 'Necessary' Test: The "How"

The term 'excepted asset' is where many BPR claims truly fall apart. An excepted asset is simply any asset in the company that is:

1. Not used wholly or mainly for the purposes of the business in the last two years.

2. Not required at any time in the future for the purposes of the business.

The classic example is surplus cash. If your business is sitting on £500,000, but its rolling working capital requirement is only £100,000, the remaining £400,000 is likely an excepted asset. For BPR to be successfully claimed, the taxpayer must prove that the asset was truly **necessary** for the company’s trading activity. Being 'prudent' or 'a rainy day fund' is usually not enough for HMRC.

Here’s the thing: The mere presence of excepted assets does not automatically disqualify the entire company. Instead, the value of the excepted assets is deducted from the total value of the company before BPR is applied. However, the problem is that the presence of high-value excepted assets often leads HMRC to conclude that the business is no longer 'wholly or mainly trading' overall, thus eliminating the entire relief.

Let's use a practical example. Imagine your company is worth £2 million, has no investment property, and is 70% trading, but it has £1 million in surplus cash earning interest. HMRC could argue that while the business is still trading, the core capital employed is dominated by a non-trading, excepted asset, causing the company to fail the BPR test entirely.

Step-by-Step: Managing the Excepted Asset Risk

1. Audit the Balance Sheet: Regularly analyze your company’s assets. Identify cash, loans to third parties, or property not used in the business. Treat these as red flags.

2. Document Business Need: For any significant cash reserve, **document** a clear, auditable business case for its retention. This might be a planned capital investment, a significant R&D project, or a fund for a large, known future contract. This converts an 'excepted asset' back into a 'trading asset'.

3. Extract Surplus: If the cash is genuinely surplus to requirements, you might consider extracting it via dividends (subject to income tax) or pension contributions (subject to annual allowance rules) to move it out of the company and protect the remaining BPR value. In the 2024/25 tax year, only **18,500** estates paid IHT, suggesting effective use of reliefs like BPR for those who plan ahead (ONS Wealth & Assets Survey, 2024).

Edge Cases / Advanced Topics

The 'wholly or mainly trading' rule is particularly tricky for what are known as **mixed businesses**—companies that trade *and* hold investments. A classic example is a property development company that builds and sells homes (trading) but keeps a few units for long-term rental income (investment). This type of mixed activity is a magnet for HMRC investigation. The question becomes: what percentage is attributable to each activity, and how is that ratio measured (time, value, or turnover)?

Another common challenge is the holding of property. If your limited company owns the commercial building it trades from, this property is typically classed as a 'trading asset' and protected by BPR. However, if the business moves, and the company retains the old building to rent it out, that asset instantly becomes an investment, and the BPR clock for the whole company can be reset negatively. **HMRC’s Litigation and Settlement Strategy (LSS)** highlights BPR claims as a key area of dispute, often revolving around the subjective definition of "wholly or mainly" (HMRC LSS Guidance, 2025).

Common Questions About BPR and Excepted Assets

Based on questions I've seen across UK business owner forums and accountancy roundtables, here are the three most common points of confusion.

Does holding cash to pay a dividend 12 months from now count as 'necessary'?

Generally, no. HMRC’s test of "necessary" is rigorous and usually applies to immediate, foreseeable trading needs—like next quarter's payroll, stock purchase for an imminent contract, or capital expenditure detailed in a board resolution. Funds retained solely for a future dividend distribution or a generic 'buy-out' fund for a shareholder are typically deemed not necessary and may be treated as an excepted asset.

If my company fails the BPR test, is all IHT relief lost on the shares?

Not always, but it’s a high risk. If the business fails the 'wholly or mainly trading' test, BPR is generally denied for the entire value of the shares. However, if the business passes the 'wholly or mainly trading' test, but has some excepted assets (like a single rental property), the value of the excepted assets is often simply carved out and charged to IHT, while the remainder of the business is covered by BPR. The risk is that the sheer volume of excepted assets causes the whole trading test to fail.

Is a Director's Loan Account (DLA) asset considered an 'excepted asset'?

Yes, a DLA that is owed money **to** the company (i.e., the director has borrowed from the company, creating an asset on the balance sheet) is generally classified as an excepted asset. This is because the director’s debt to the company is a passive, non-trading investment that is not being used for the company’s day-to-day trading activities. This can skew the balance sheet and damage the overall BPR claim, making timely DLA repayment critical.

Conclusion: Your Next Steps

Understanding BPR comes down to three core principles: **Know Your Ratios**, ensuring the company is demonstrably more than 50% trading; **Know Your Assets**, identifying and documenting the business need for every significant non-current asset; and **Know Your Plan**, actively managing surplus funds to prevent them from becoming BPR-killing excepted assets. For directors, the most impactful first step is a comprehensive review of your company’s balance sheet to identify and justify any large cash balances or passive investments. If you’re not sure about the 'wholly or mainly' status of your business, especially if it’s a mixed entity, a tax professional can provide a board-ready opinion based on case law. However, BPR rules are intricate and the financial penalties for an incorrect claim are severe—this guide provides a necessary framework, but for your specific business’s structure and future plans, always consult a qualified IHT specialist.