Lee Sharpe looks at two tax cases that highlight some of the intricacies of capital gains tax business asset disposal relief.
Capital gains tax (CGT) business assets disposal relief (BADR) may have been introduced only fairly recently in 2020 but it is, of course, based on entrepreneur’s relief (ER), which first aired in April 2008, although it has been subject to various refinements over the years, as the government has largely sought to limit the utility and availability of the relief (veteran readers may well recall that ER was itself hastily carved out of the ancient retirement relief regime).
This article looks at two fairly recent tax cases that may be of use to current BADR claimants, even though they arose from assessment years when ER was in point.
#1 Extent of non-trading activities
BADR is available in respect of shares, etc., in ‘trading companies’ or ‘trading groups’ (phrases that somewhat circuitously derive their meaning from TCGA 1992, s 165A); and qualifying companies (or groups) must not include ‘to a substantial extent’ activities other than trading activities.
So, what is a ‘substantial extent’ of non-trading activities that might prove fatal to a claim?
In terms of ER and latterly BADR, HMRC has long stood by a rule of thumb of 20% and applied it to a basket of indicators, including:
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incomes from non-trading activities (relative to the whole);
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how the asset base of the company is split between trading and non-trading; and
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outlay of time and or financial resources.
To be fair to HMRC, its Capital Gains Manual has long accepted that it was not simply a case of finding a particular test for the company to fail, but that HMRC was obliged to look at the business ‘in the round’ and consider where the balance lay, having regard to a range of factors. However, break enough 20% thresholds and HMRC would argue that non-trading activity was too substantial to be ignored, and ER or BADR would be refused. This approach was tested in Allam v HMRC [2020] UKFTT 0026 (TC), and HMRC’s 20% limit was found lacking:
“As regards the HMRC guidance, we can understand that it is useful for HMRC staff to have some practical guidance to assist them in the application of the legislation, but there is no sanction in the legislation for the application of a strict numerical threshold…in our view, “substantial” should be taken to mean of material or real importance in the context of the activities of the company as a whole.”
Having said that, the First-Tier Tribunal did find that the company’s long-term rental and ancillary activities were not trading and had to be regarded as substantial in the context of the company’s activities in the round, so ER was not due on the disposal of the shares in the relevant company. The company was given leave to appeal to the Upper Tribunal (UT) on this point, which endorsed the FTT’s approach at Allam v HMRC [2021] UKUT 0291 (TCC), which may help potential claimants in their quest for clarity, but alas for Dr Allam, simply reaffirmed his particular claim should be denied:
“[I]n considering the activities of a company, the test is a holistic one. The test is not confined to physical human activity, but requires an overall consideration of what it is that the relevant company does.”
So, while the taxpayer may have lost, HMRC has effectively been ‘told off’ for applying its basic 20% tests so dogmatically. This has worked its way through to HMRC’s guidance – see, for example, HMRC’s Capital Gains Manual at CG64090, which now includes extracts from the UT’s decision and states:
“For practical purposes it is likely that from accounts submitted some consideration can be given to the level of non-trading income and the asset base of the company. Where neither of these suggest the non-trading element exceeds 20% the case is unlikely to warrant any more detailed review [emphasis added].”
From this, we might infer that HMRC is not keen to get bogged down in nuance and interpretation, but will instead take a pragmatic view and argue cases only where it perceives a clear slant towards non-trading activity in terms of the income and asset base.
#2 How slowly can you sell a business?
A key criterion in the legislation is that the taxpayer must make a ‘material disposal of business assets’, which distils down to ‘the whole or part of a business’. Readers may already be aware that a simple disposal of some assets on their own will not normally comprise part of a business; simply put, what is disposed of must be capable of being run as a business, to qualify (TCGA 1992, s 169I).
However, note that the disposal of one or more assets alongside a qualifying disposal (the typical scenario being where the trader sells personally owned business premises alongside an already qualifying sale of shares or partnership interest) may pass as an ‘associated disposal’ (TCGA 1992, s 169K).
In Thomson v HMRC [2021] UKFTT 453 (TC), the taxpayer (an accountant) slowly sold his interest in the partnership’s work in progress and client base in stages, starting in 1996. Alongside this, the taxpayer sold the business premises to his pension scheme in 2017/18 and claimed ER on the property disposal. Perhaps understandably, HMRC tried to argue that the gain on the business premises did not rank as a qualifying disposal of a business on its own, and the very slow transfer of the other partnership assets should not be aggregated therewith to amount to a qualifying ‘material disposal’ – in effect, HMRC was trying to test the ER/BADR rules against only the disposal of the business premises, against which ER had been claimed in 2017/18.
The First-tier Tribunal noted that there were no particular limits on the time taken to dispose of the main qualifying business or interest in a business (although there certainly are time limits in the regime, including for making a valid claim and for making a separate disposal that may be associated with the main qualifying disposal). The court also noted that:
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the legislation did readily accommodate disposals of various assets that might take place in different tax years but could nevertheless amount to a qualifying material disposal;
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there were valid commercial reasons for the time taken to effect the transfer, such as dealings with complex estates, and an overhanging threat of litigation; and
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HMRC’s argument that one should consider only those disposals that amounted to chargeable disposals for CGT purposes was firmly rejected (i.e., one should take a wider view of the transactions involved and not consider only the assets which were the subject of the ER claim).
Conclusion
The above cases show that even relatively ‘old’ or supposedly well-established regimes can still throw up some unusual technical points. Readers may conclude that the second case was so unusual as to have little utility, but I might counter that any case potentially discouraging HMRC from making quite adventurous and inconsistent interpretations is to be cherished.
On the other hand, one might also ponder that while HMRC’s relatively rigid 20% thresholds were criticised at both tribunal hearings in the first case, the decisions and even the subsequent, ostensibly more subdued guidance in HMRC’s Capital Gains Manual at CG64090 are not wholly good news; briefly, at no stage did I see the courts insist that a 20% threshold was inherently too low for something to be ‘substantial’.
