Entrepreneurs’ relief (ER) reduces the rate of capital gains tax (CGT) on disposals of certain business assets from 20% to 10%, to be able to claim ER, a series of conditions have to be met and one of them is where the shares are sold, the company must be a trading ( or Holding company of a trading group ).
Summarising the effect of ER :
- 10% CGT rate on disposal of qualifying assets;
- whole or part of a sole trade or partnerships;
- assets used in a business; or
- shares in a trading company;
- £10m lifetime limit per individual;
The individual, if selling shares, needs to fulfil all the following:
- be a director / employee up to the date of disposal;
- own 5% of share capital – note this is based on the nominal value, rather than simple number of shares;
- be entitled to 5% of voting rights;
- 1 year holding period and employment / directorship required to qualify;
Where shares are sold, the company must be a trading company (or holding company of a trading group;)
Shares acquired by exercising qualifying EMI share options don’t need to meet the 5% rule above
The recent first-tier tribunal case re-emphasises the importance of ‘trading activities’, but it also clarifies that a company can diminish or temporarily suspend its trading activities without being treated as ceasing to trade. It also addresses the issue of when an investment activity leads to the loss of ER.
Mr and Mrs Potter were shareholders in a company called Gatebright Ltd which had traded as a broker on the London Metal Exchange. Mr Potter dealt with trading, and Mrs Potter dealt with the administration of the business.
Gatebright was a successful business and had built up reserves of over £1m when the financial crash happened in 2008/09. In order to safeguard the reserves, Gatebright invested £800,000 of the company cash reserves in a six year investment bond which matured in November 2015. The bond paid interest of £35,000 a year and it appears that this was distributed by way of dividend. The remaining funds, approximately £200,000, were retained as working capital.
As a result of the crash, the volume of trade declined dramatically and the last invoice issued by Gatebright was in March 2009.
From 2009 until June 2014, Mr Potter suffered some ill-health and other domestic misfortune which meant that he was unable to work and so the trading activities diminished or were temporarily suspended. However, having been in the business for 30 years, Mr Potter had many contacts among banks and clients and he stayed in touch with them with a view to starting new negotiations. Evidence was produced demonstrating that the company was actively seeking trading income right up to June 2014.
The company went into Members voluntary liquidation (MVL) in June 2015. ER was claimed but denied by HMRC on grounds that the company ceased trading in 2009, more than three years before the 2015 disposal date.
A key requirement for the availability of ER in a share disposal is that the company is a trading company or a holding company of a trading group throughout the qualifying period.
In order to meet the trading company requirement, a company’s activities must not include non-trading activities to a significant extent. Although ‘significant’ is not defined in the legislation, HMRC’s manual looks at ‘indicators’ or ‘factors’ that might be useful in establishing whether there is substantial overall non-trading activity. This is traditionally taken to be 20% and this figure is included in HMRC’s guidance. The guidance is, of course, just that. It is not legislation.
The tribunal observed that the legislation focuses on ‘activities’, in other words ‘what is the company actually doing?’
The tribunal concluded that, although Gatebright was not actually carrying on any trade after it issued its last invoice in 2009, it was considered to be ‘preparing to carry on its old trade once the economic environment permitted it’. The expenditure and the time spent by the officers/employees of the company on non-trading activities were nil. Once Gatebright put the money into the bonds it did not, and could not, do anything else in relation to them until they matured. There were no investment activities.
While the asset and income position of the company were factors against trading activities, the expenses incurred, and time spent by the directors/employees, were factors pointing to trading activities.
The tribunal supports the view that a trading company may be able to make a substantial long-term passive investment without fear of losing its ER trading company status.
It also highlights the importance of actions taken with the judge stating in reference to a period of suspended trade ‘it does not seem to me that a company would stop and start being a trading company in a period simply because trading activities are temporarily suspended for some reason. Carried to a logical extreme, if this is wrong, a company would cease to be a trading company every weekend and become one again every Monday morning. If, overall, the company is carrying out trading activities during a period but there are temporary gaps in the activities, in my view it can be said that the company is a trading company “throughout” the period.’
Please contact a member of our team if you would like to discuss any of the issues raised.
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