Inheritance Tax on Business Assets: Navigating the BPR 'Wholly or Mainly Trading' Trap (2025 Guide)

Picture this: You’re a successful founder in Leeds. Your private limited company is valued at £2 million, and you’ve always believed it was 100% exempt from Inheritance Tax (IHT) thanks to **Business Property Relief (BPR)**. But your company also holds £500,000 in cash reserves from years of retained profit, which is currently sitting in a savings account earning interest, and you also own the commercial property that the business operates from. Are you really protected from IHT? Or could HMRC argue your company isn't actually 'wholly or mainly trading,' cutting your IHT relief to zero? If this scenario feels uncomfortably close to home, you've hit on one of the most complex and expensive IHT planning traps facing UK business owners.

The stakes here are enormous. Getting the application of BPR wrong can transform a potential 0% IHT bill on a multi-million-pound business into a 40% liability, potentially forcing the sale of the business to pay the tax. While BPR is designed to preserve family businesses, its rules—particularly the 'wholly or mainly trading' test—are strictly applied and open to interpretation. I’m Alex Williams, and having spent years building tools to simplify complex HMRC regulations, I’ve seen firsthand how this grey area trips up even experienced directors. Let's explore exactly how this relief works, where the trap lies, and what you can do to protect your legacy.

The 'Wholly or Mainly Trading' Test: Defining the Line

To qualify for BPR at the 100% rate, your business must not be seen by HMRC as primarily a passive investment vehicle. The legislation (Inheritance Tax Act 1984, s.105) uses the phrase, 'wholly or mainly one of dealing in securities, stocks or shares, land or buildings, or making or holding investments.' Let's explore the fundamental concept using an analogy.

Think of your business as a train: if the engine (trading activity) is more powerful than all the passenger cars (investment activity), you're fine. If the investment activities start to weigh down the train, HMRC might stop it and revoke its BPR ticket. For a manufacturing company actively producing goods, the line is clear. For a consultancy firm holding a large portfolio of rental properties, the line is extremely blurry.

This matters because HMRC applies a qualitative rather than a purely quantitative test. The 'mainly' threshold is widely considered to be a minimum of **51%** of your business activity being trading in nature. However, HMRC doesn't rely on just one metric. They will scrutinise four key areas, giving weight to all of them before determining if BPR applies (HMRC IHTM25261, 2024). A business might look like an investment company on one metric but qualify based on the others.

Let's look at a statistic that underlines the complexity. According to a 2024 paper from the Office for National Statistics (ONS) on IHT receipts, the total IHT take hit a record high of £7.5 billion in 2023/24 (ONS, 2024), partly due to property growth and the complexity of reliefs. The key takeaway for business owners is that BPR is a significant, high-value target for HMRC investigation.

Scenario-Based Breakdown: The BPR Trading vs. Investment Test

To make sense of how HMRC assesses 'wholly or mainly trading,' let's break down the four most common assessment metrics. The table below shows how a single £2 million business can be viewed very differently depending on which metric HMRC chooses to prioritise.

As you can see, the same private company valued at £2 million can face four completely different interpretations of the 'wholly or mainly trading' test depending on its activities. This is why generic 'my business is trading' advice often fails—HMRC will look at the entire picture and use the combination of metrics that best represents the company's true nature. A key pitfall is the **'Excepted Assets'** rule, which exists even for a company that passes the trading test.

Deep Dive: The Excepted Assets Trap and Practical Solutions

So, you've managed to prove your company is 'mainly trading' (e.g., 60% of its activities are trading). Congratulations! Now you hit the second hurdle: **Excepted Assets**. Even if your business qualifies for BPR, any assets within the company that are not used 'wholly or mainly for the purposes of the business in the two years immediately preceding' the owner's death are excluded from BPR relief. These assets will be subject to the full 40% IHT rate.

Imagine your company holds £300,000 in cash that is simply sitting in a high-interest account, or it owns a small flat in central London that the directors rent out for holidays. These are classic Excepted Assets. They are not required for the day-to-day running of the trade and therefore provide passive investment value.

Here's the thing: You might think you need large cash reserves for future expansion. HMRC is skeptical. They will compare the cash held to the business's operating costs, capital expenditure plans, and liabilities. Unless the funds are demonstrably earmarked for a specific, immediate trading purpose—like buying new machinery or paying a known tax bill—HMRC can successfully argue it's an Excepted Asset.

The solution here is practical implementation. According to HMRC’s published guidance (HMRC IHTM25283, 2025), two years is the relevant look-back period. This means you have a window to restructure your company to protect its value.

Step-by-Step: Removing Excepted Assets to Protect BPR

1. Identify Excepted Assets: Conduct an annual audit of your balance sheet. Identify all non-trading assets: excess cash reserves, rental properties, stock market investments, or land plots without planning permission for business use.

2. Demonstrate Trading Use: If cash is truly needed, create documented, board-approved resolutions earmarking funds for specific trade purposes (e.g., '£150k reserved for purchase of new industrial laser cutter on 01/04/2026'). HMRC must see a clear, commercial trading justification for the asset.

3. Extract the Excess: If the assets are truly surplus, consider extracting them. This might involve the director taking them out as a dividend (subject to Income Tax) or, if the business has substantial value, setting up a **holding company structure** to ring-fence the trading assets from the investments. A holding company can then distribute the investment assets to shareholders, or they can be used to fund an alternative IHT strategy outside of the BPR mechanism.

Common Questions About BPR and the Trading Test

Based on questions I’ve seen across UK business forums and in discussions with accountants, the BPR test generates three persistent points of confusion.

Does holding the company's commercial property automatically fail the BPR test?

No, not if the company owns and uses the property for its own trade. An asset is **not** an Excepted Asset if it is used 'wholly or mainly for the purposes of the business' (HMRC IHTM25275, 2024). For instance, the factory building used by a manufacturing company is a trading asset. However, if the business owns three buildings and only uses one, the other two (if rented out) are almost certainly Excepted Assets.

If my company holds one large investment, will I automatically lose BPR?

Not necessarily. The 'wholly or mainly' test looks at the business **as a whole**. If a limited company’s primary activity (measured by turnover, time, and expenses) is trading—say, 80%—the presence of one large, passive investment doesn't automatically fail the entire BPR claim. The large investment's value will be excluded as an **Excepted Asset** and taxed at 40%, but the remaining 80% of the trading business's value will still qualify for 100% BPR. The only way to lose BPR on the *entire* business is if the investment activity breaches the 'mainly' (51%+) threshold.

What about businesses with a large amount of retained profit (cash in the bank)?

This is one of the biggest traps. Cash in the bank is only a trading asset if it can be demonstrated that it is needed for the day-to-day running or immediate, specific future needs of the trade. If a business has £500,000 in cash but only spends £50,000 annually, HMRC will likely treat the £450,000 excess as an Excepted Asset, and it will be subject to IHT at 40%. The key is to document a genuine, short-term commercial need for those funds, otherwise, they are viewed as passive.

Conclusion: Your Next Steps

Understanding BPR comes down to three core principles: you must prove your company is **mainly trading** (not an investment holder), you must ensure its assets are **used for the trade** (to avoid the Excepted Asset trap), and you must proactively document all commercial justifications for holding surplus cash. Remember, BPR is a 'relief'—and HMRC is meticulous when assessing its application. The most robust planning involves a full audit of your business activities across all four HMRC metrics. For most owners, the first step is reviewing the balance sheet to identify and address Excepted Assets now, while you have the time to do so. However, IHT rules are intricate and penalties for errors are severe—this guide provides a framework, but for your specific business structure and IHT planning, always consult a qualified IHT specialist or accountant who has deep experience with the 'wholly or mainly trading' test.