For those taxpayers selling or gifting a whole or part of their business, HMRC offer a valuable capital gains tax relief for qualifying disposals. This is under the guise of entrepreneur’s relief (formerly retirement relief), up to the current lifetime threshold of £10 million.
The regime is available to the following:
- Sole traders and partners.
- Company directors and employees providing they hold ordinary share capital of at least 5%.
In order for the disposal to be “qualifying”, there must be a material disposal of business assets, a disposal associated with a material disposal, or a disposal of trust business assets.
Tax legislation dictates that the following circumstances would constitute a material disposal of business assets providing they have been held for a minimum period of 12 months prior to that date:
- Disposal of the whole or part of a sole trade/partnership business.
- Disposal of a business asset in use at the point of cessation.
- Disposal of shares or securities in a company.
Of the points listed above, by far the most contentious is the issue of a part business disposal. There is considerable case law surrounding this area as HMRC dictate that the part disposed of must be capable of operating as a going concern in its own right post transaction. As a result, a simple disposal of an asset/(s) used in the course of trade is unlikely to qualify.
Care must also be taken to ensure that the correct “type” of business is being disposed of as for Entrepreneur’s Relief to be available, the company must either be trading or the holding company of a trading group. HMRC define a trading company as “a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”.
Quite unhelpfully as is often the case, HMRC do not define what exactly constitutes a “substantial extent” in their opinion. It is known that the Revenue considers “substantial” to be more than 20% and therefore by inference, you would conclude that providing 80% of the company’s activities related to trading, you would likely be safe. If your next question is to what aspect of the company’s figures do you apply the percentage test to? However that is also not specified in the legislation…
A further potential pitfall is that the business unwittingly excludes a proportion of its balance sheet from qualifying. An example of this would be for a cash-rich business holding considerable reserves to place these funds within an investment vehicle. The onus would then be on the taxpayer to justify the asset’s usage within a trading outfit. One of the best tools I have come across in determining whether you have a trading business or not is the application of the “duck test”:
“If something looks like a duck, walks like a duck and quacks like a duck, the balance of probability is that the thing before you is a duck.”
Therefore, if the company looks and feels like a trading company, to all intents and purposes it probably is.
Lisa Garfinkle – Barrons