Ken Moody points out some ‘conundrums’ in the capital gains tax entrepreneurs’ relief rules.
For a short piece of legislation, capital gains tax (CGT) entrepreneurs’ relief throws up more than its fair share of conundrums.
‘Material’ and ‘associated’ disposals
It is vital to appreciate the difference in the tax treatment between a ‘material disposal’ and an ‘associated disposal’, and also the distinctions between different types of material disposal. References in this article are to TCGA 1992.
First off, it must be understood that for a disposal to qualify as an associated disposal (s 169K), there has to be a material disposal (s 169I) with which it is associated.
Therefore, for example, where an individual disposes of property which is used by his ‘personal company’ (as defined by s 169S(3)), ER is available only if there is a material disposal of shares in the company within section 169I(c) and the various conditions at section 169K are met. One of these is that the disposal is part of the individual’s withdrawal from the business (Condition B - see HMRC’s Capital Gains manual at CG63998); another is that the asset must be used by the company throughout one year ending with the earlier of the date of the material disposal or the cessation of the business (Condition C).
Perhaps curiously, s 169K does not specify any time limit following either of those events by which the associated disposal must occur, though HMRC’s guidance at CG63998 states: ‘… there should normally be no significant interval between the two disposals’.
However, in the case of a partnership or company, HMRC will allow up to three years following the material disposal for the associated disposal to occur.
A big ‘no-no’ though is the disposal of an asset prior to the material disposal because this will not meet Condition C (unless the asset remains in use until the date of the material disposal or cessation of the business, e.g. pending completion of the sale). Such a disposal will, therefore, not qualify for ER.
Meeting the conditions
Section 169I(2) recognises three types of disposals of business assets. Company shares have already been mentioned. The other two categories are:
(a) the disposal of a business or part of a business; and
(b) the disposal an asset used in the business at the time the business ceases.
Section 169I then goes on to list the conditions which must be met for the disposal to qualify as a material disposal.
In relation to (b) above, the conditions are ownership of the business by the individual throughout one year ending with the cessation and the disposal of the asset within three years of that date (s 169I(4)). It is not necessary that there should be a disposal of the business, and so ‘shutting up shop’ without a sale is sufficient for ER to apply to assets realised post cessation.
Such disposals are themselves material disposals, not associated disposals with the restrictions on use, payment of rent, etc., which that entails. Incidentally, section 169I(2)(b) simply requires the use of the asset in the business at the time it ceases – not that it should be used wholly for that purpose. Neither does section 169I(4) place any conditions upon the use of an asset following cessation and prior to disposal (within three years).
Where a business ceases, the timing of asset sales may be crucial unless these are sold as part of a business (within s 169(2)(a)). There is a small body of case law concerning what constitutes a part of a business, mostly related to farming, though this is beyond the scope of this article (see HMRC’s guidance at CG64015 onwards).
Practical Tip:
In some cases, it might be practicable to arrange for the cessation of trading activities to coincide with the sale of a major asset. In a situation where, in winding down a business asset is sold but trading continues, two problems arise. As noted, there has to be cessation of a business for the disposal of any asset used in the business to qualify for ER under s 169I(2)(b). Secondly, the sale of an asset while the business continues (unless the sale itself constitutes a part of a business) also does not meet the requirement in section 169(2)(b) that the asset must be in use at the time the business ceases.
