Mark McLaughlin looks at business asset disposal relief for capital gains tax purposes, and when a company’s activities might be non-trading to a ‘substantial’ extent.
Many business owners are familiar with business asset disposal relief (BADR), which offers individuals a capital gains tax rate of 10% on net chargeable gains, up to a lifetime limit of £1 million.
A claim for BADR is available on a material disposal of business assets. This article focusses on one category of business asset disposal, i.e., shares in a company. A disposal is ‘material’ for BADR purposes if one of four alternative conditions is met (i.e., A to D in the legislation). The most common one is Condition A. This is that throughout a two-year period ending with the date of disposal: the company is the individual’s personal company and is a trading company (or the holding company of a trading group), and the individual is an officer or employee of the company (or a trading group member, if applicable) (TCGA 1992, s 169I(6)).
A ‘trading company’ for BADR purposes is defined as a company carrying on trading activities whose activities do not include non-trading ones to a substantial extent. Unfortunately, the legislation does not define ‘substantial’. This has caused uncertainty for many company owners about whether their shares are eligible for BADR.
What is ‘substantial’?
HM Revenue and Customs (HMRC) provides guidance on its interpretation of the meaning of ‘substantial’ for BADR purposes in its Capital Gains manual at CG64090. It states that ‘substantial’ in this context means more than 20% – but 20% of what?
HMRC’s guidance states that some or all of certain measures or indicators are among those that may be taken into account in reviewing a particular company’s status:
- income from non-trading activities;
- the asset base of the company;
- expenses incurred, or time spent by officers and employees of the company in undertaking its activities;
- the company’s history; and
-
the balance of indicators.
HMRC’s suggested approach is that the relevance of each indicator be weighed up in the context of the case and judged ‘in the round’. Of course, HMRC guidance does not generally carry the force of law. That point was highlighted in Allam v Revenue and Customs ([2021] UKUT 291 (TCC)).
Not a helpful test
In Allam, the taxpayer’s claim for entrepreneurs’ relief (now BADR) on a sale of shares was unsuccessful. The company’s business involved property development and property investment. The First-tier Tribunal (FTT) concluded that the company’s non-trading property investment and rental activities had to be regarded as substantial in the context of all the company’s activities. The Upper Tribunal (UT) subsequently held that the holding of investments was an ‘activity’.
Interestingly, the tribunals did not find HMRC’s 20% threshold test of ‘substantial’ to be particularly helpful. The UT’s comments in Allam also indicated that the ‘activity’ test is not reliant solely on a physical activity.
Practical tip
A common point of uncertainty on the ‘substantial’ non-trading activities test is often referred to as the ‘surplus cash’ issue. Some commentators have suggested that the retention of accumulated profits in (for example) a non-interest bearing current account of the company would preclude HMRC from arguing there was an investment activity. Nevertheless, taxpayers and advisers may wish to consider a non-statutory clearance application to HMRC with a view to obtaining comfort on this point.
