Ken Moody analyses what may be regarded as ‘substantial’ non-trading activity affecting a company’s status for various capital gains tax relief purposes in the light of recent case law and its effect of non-statutory clearance applications.
Capital gains tax (CGT) and business asset disposal relief (BADR) may apply to a disposal of company shares provided that:
- the company is the individual’s personal company;
- the company is an unquoted ‘trading company’ or ‘holding company’ of a ‘trading group’;
- the shares have been held for two years (for disposals on or after 6 April 2019).
Trading company?
The above terms are defined by TCGA 1992, s 165A. ‘Trading company’ is defined by reference to its ‘activities’, being activities carried on ‘in the course of, or for the purposes of a trade being carried on by it’ (s 165A(4)), and includes pre-trading activities.
The further proviso is that the company’s activities must not include non-trading activities ‘to a substantial extent’. What is ‘substantial’ is not further defined. Many readers will be familiar with HMRC’s ‘rule of thumb’, which proposes a 20% test by reference to certain ‘indicators’ as described in its Capital Gains manual at CG64090:
- Income from non-trading activities;
- The company’s asset base;
- Expenses incurred or time spent;
-
The company’s history.
The guidance does stress, however, that no single indicator is conclusive and that a judgement should be made ‘in the round’.
A practical approach
HMRC’s guidance at CG64060 states: ‘the long-term retention of significant earnings generated from trading activities may amount to an investment activity. The first point to consider is whether or not there is any identifiable activity distinct from the trading activity.’
In Jowett v O’Neill & Brennan Construction Ltd [1998] STC 482, it was held that holding cash on bank deposit was not carrying on an investment business, which would therefore appear not to be an identifiable activity. In such circumstances, the company’s asset base may be a poor indicator of the level of activity. Cash on deposit or perhaps long-term investments might be well in excess of 20% of the total asset base but represent little or no activity.
In Potter v Revenue and Customs [2019] UKFTT 554 (TC), the First-tier Tribunal found that the Potters’ family company qualified as a trading company for the purposes of claims for CGT entrepreneurs’ relief, although its trade had been in abeyance for some years. During that period, the company had invested in six-year bonds, which provided its income. Meanwhile, the directors sought unsuccessfully to revive the trade, but eventually the company was liquidated. While the asset and income position of the company pointed away from trading, the tribunal held that it was not carrying on an investment activity and that it had been carrying on trading activities with a view to reviving its trade.
Is that clear?
HMRC (at CG64100) invites applications for non-statutory clearance where there is ‘genuine doubt’ as to the company’s trading status, which could be especially relevant where part of its activities might be regarded as investment.
Since Potter, however, experience suggests some signs of reluctance or even refusal by the non-statutory clearance team to entertain applications regarding a company’s status for the purposes of s 165A.
Practical tip
HMRC frequently state that they will not give rulings on questions of fact. I have previously obtained non-statutory clearance based on CG64100 that holding cash on deposit did not amount to an activity (in relation to which the 20% test would therefore not be relevant). Following Potter, that may be a sensitive issue. My current approach is to phrase the application strictly in terms of the guidance at CG64100 and thereby give no grounds for rejection. Each indicator, of course, involves factual data, but, as noted earlier, the bare facts such as the company’s asset base do not reveal the relative levels of activity. The final ‘balance of indicators’ should therefore take a holistic view of the levels of activity that any non-trading activities represent in applying the 20% test.
