Mark McLaughlin looks at a change in HMRC guidance following an important case on business asset disposal relief for capital gains tax purposes.
Business asset disposal relief (BADR) (previously entrepreneurs’ relief (ER)) offers a capital gains tax (CGT) rate of 10% on net chargeable gains of £1m if certain conditions are satisfied.
For example, when an individual shareholder disposes of shares in a company, one of the relief conditions is that throughout a two-year period ending with the date of disposal, the company is a trading company (or holding company of a trading group).
Is it ‘substantial’?
A ‘trading company’ for BADR purposes is a company carrying on trading activities whose activities do not include non-trading activities to a substantial extent. ‘Substantial’ is not defined but has been widely accepted to mean more than 20% of certain measures including income from non-trading activities, the asset base of the company, or expenses incurred or time spent by officers and employees of the company in undertaking its activities.
For some time, the approach suggested by HMRC (in its Capital Gains manual at CG64090) was to weigh up the relevance of each indicator in the context of the case and judge the position ‘in the round’ (following the IHT case Farmer and another (exors of Farmer dec’d) v IRC [1999] SpC 216).
However, HMRC replaced that guidance early in 2022, following Allam v Revenue and Customs [2021] UKUT 291 (TCC). In that case, the company had a significant investment portfolio. The key question was whether this amounted to substantial non-trading activity for ER purposes. The Upper Tribunal (UT) stated:
“We accept that the reference to ‘activities’…is in the sense of what the company actually does, but the question of what the company actually does must be looked at in commercial terms. In that sense, trading is an activity, but so too is holding an investment property and receiving rents…there may be little action required on the part of directors and employees in such an activity, but it remains an activity in commercial terms.”
The UT found that holding investments was an activity for ER purposes. Hence the company was carrying on activities which were, to a substantial extent, not trading activities.
A change: but not for the better
Following Allam, HMRC amended its guidance at CG64090 on the meaning of ‘substantial’ to remove the passage “substantial in this context means more than 20%” and refer to Allam, including the above UT comment (in expanded form) to the effect that passive investments still count as ‘activities’ for the ‘substantial’ test.
No reference is made at CG64090 to Potter v Revenue and Customs [2019] UKFTT 554 (TC). In that case, it was held that there was no investment activity in an interest-bearing bond where the investment was tied up for six years and the company did not have to do anything in relation to the investment.
The UT in Allam commented on the decision in Potter: “[The tribunal] does seem to have placed considerable weight on the absence of any physical activity in relation to the investment bond. Indeed, it seems to have viewed that as not involving any activity at all. We do not consider that the tribunal was right in that regard.”
Practical tip
Is the 20% ‘substantial’ test redundant following Allam? Possibly not. HMRC’s guidance (at CG64090) 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.”
