Mark McLaughlin looks at pre-trading activities for capital gains tax business asset disposal relief purposes.
Business asset disposal relief (BADR) is a very popular relief for individual business owners, offering a capital gains tax rate of only 10% on chargeable gains from qualifying business disposals, subject to a lifetime limit of £1 million.
A ‘business’ for BADR purposes means anything which is a trade (or profession/vocation) and is conducted on a commercial basis and with a view to the realisation of profits (TCGA 1992, s 169S(1)).
The various conditions for claiming BADR are not covered in this article, but it is important to note that they differ for company shareholders and the self-employed. A significant distinction is in how HM Revenue and Customs (HMRC) applies the BADR rules to pre-trading activities for prospective businesses.
Getting prepared
For example, a ‘trading company’ is a company carrying on trading activities which do not include non-trading activities to a substantial extent. ‘Trading activities’ include (among others) activities carried on by a company for the purposes of a trade it is preparing to carry on (e.g., developing business plans, acquiring premises, hiring staff, ordering materials, etc.) (see HMRC’s Capital Gains manual at CG64065).
However, ‘trading activities’ are defined in the context of a company, not an unincorporated business such as a partnership. In the absence of an explicit reference to a partnership’s pre-trading activities, could the BADR rules be interpreted as treating companies and partnerships the same in this context? Unfortunately, it seems not.
Partnerships vs companies
In Wardle v Revenue and Customs [2021] UKFTT 124 (TC), the taxpayer was one of three partners who, in January 2014, formed a partnership to develop, construct and operate renewable power plants at three locations in the UK. The partnership commenced pre-trading activities on 1 May 2014. When the projects reached the stage where construction could begin, the partnership sold two plants to a third party, in August and November 2015 respectively. The partnership had not commenced trading at that point. The taxpayer claimed entrepreneurs’ relief (ER, now BADR) on his share of disposal proceeds in his tax return for 2015/16. HMRC denied the ER claim. The taxpayer appealed.
The First-tier Tribunal (FTT) considered that the ‘natural and ordinary’ meaning of a ‘business’ required that an individual or partnership was disposing of something that was at that time a trade. The trade must exist at that time; it did not extend to activities capable of being conducted as a trade at some future point. The FTT found ‘striking’ the difference in ER treatment between partnerships and companies in terms of pre-trading activities. The FTT concluded that a disposal by a partnership only constituted a disposal of the whole or part of a business if the partnership had commenced trading. Therefore, the disposals by the partnership were not a material disposal of business assets and did not qualify for ER.
It follows that company shareholders appear to have an advantage over individuals or partnerships in respect of pre-trading activities for BADR purposes.
Practical tip
Individuals planning to start a new business should (following Wardle) consider operating it as a company and undertake preparatory activities prior to the commencement of trading through the company, particularly if such activities are likely to be a factor in the availability of BADR (e.g., in terms of whether the two-year trading requirement is satisfied on a future disposal of the individual’s shares).
