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Business taper relief

The Chancellor confirmed one very significant change on capital gains tax business asset taper relief. He has also announced some important measures to simplify CGT taper relief and other rules. The annual CGT exemption has also been increased. The more significant changes are as follows:

(1) Business Assets Taper Relief

(a) Rates

The Chancellor has confirmed that full 75% business assets taper relief will be available meaning that a 10% effective rate for higher rate tax payers and 5% effective rate for basic rate taxpayers will apply if business assets have been owned for two years and the disposals takes place on or after 6 April 2002. For those who dispose of business interests with one full year of ownership, business assets taper relief will be available at 50%.

The business assets taper relief operates like this:

Up to 5 April 2002 From 6 April 2002
Period asset held
% of gain chargable Effective rate of CGT for higher rate taxpayers % of gain chargable Effective rate of CGT for higher rate taxpayers
0-1 100% 40% 100% 40%
1-2 87.5% 35% 50% 20%
2-3 75% 30% 25% 10%
3-4 50% 20% 25% 10%
4> 25% 10% 25% 10%

Greater entrepreneurial investment has been encouraged by the reduction of the taper relief period to 2 years. As can be seen from the table a higher rate taxpaying individual who had owned qualifying assets for the full 2 years would pay an effective rate of 10%. Of course, the higher rate of tax would remain at 40%. Taper relief would operate to reduce the gains subject to tax and, thus, the effective rate of tax payable on the whole (unreduced) gain.

This change was known about in advance but is important and worth remembering. The change applies for disposals made after 5 April 2002.

6 April 2002 was, in any event, a key date for many owners of shares qualifying for business assets taper relief. Under the previous rules, from that date the full 75% taper relief would apply for those shareholders who dispose of shares that have qualified for business assets taper relief throughout a four year period commencing not earlier than 6 April 1998.

Many business sale strategies will have been constructed with this in mind. As a result legitimate deferral strategies having been entered into so as to defer the effective date of disposal for tax until after 5 April 2002. After all a 10% effective rate of CGT for a higher rate taxpayer is certainly worth waiting for. For many this may well have caused them to simplify disposal plans that may have otherwise been considered in order to defer or avoid CGT. The lower the effective rate of tax the lower (generally speaking) is the incentive to avoid it.

Now, only two years of ownership is needed, provided the disposal occurs after 5 April 2002. This further improvement to business assets taper relief also makes qualification for it of even greater importance.

(b) Anti-avoidance

The Government has proposed to abolish the rule in paragraph 11 Schedule A1 TCGA 1992 that causes past taper relief to be lost when a close trading company undertakes a relevant change of activity. Instead any period of time when a close company is not active will not count for business asset taper relief on the shares in that company.

Previously under paragraph 11 if a trading company underwent a relevant change in activity, the period of time between the date of acquisition of the shares (or 6 April 1998 if later) and the date of disposal of the shares did not count for taper relief purposes. In effect the taper relief clock could start again from scratch.

One of the ways in which a company could undergo a relevant change of activity would be if it begins to carry on a business of holding investments or increases the size of that investment business.

The meaning of this wording caused considerable confusion and anxiety and could for example, have meant that if a company invested a sizeable amount of cash into a single premium investment bond that this could amount to a company beginning to carry on a business of holding investments with the consequent loss of business asset taper relief to date.

The Chancellor&#39s proposal will clarify matters and mean that provided the company remains active as a trading company, the ownership of investments will not cause a complete loss of business asset taper relief. However, care must also be exercised with paragraph 22 which is still in existence. This deals with the thorny issue of the meaning of a trading company – a prerequisite to qualification for business assets taper relief on shareholdings.

A trading company is a company which is either a company existing wholly for the purpose of carrying on one or more trades, or a company that would fall within that definition apart from any purposes capable of having no substantial effect on the extent of the company&#39s activities.

Would a company making a substantial investment have any impact on its status as a qualifying company?

In this respect it would seem that if the purpose of the investment was to realise further cash that could be used to meet the company&#39s trading requirements, including future expansion, such an investment would not be regarded as having a “substantial effect” on the company&#39s activities. But what if the investment is not made to fund such a future trading requirement? Well then it is necessary to determine if the investment has a “substantial effect” on the company&#39s activities.

The Inland Revenue consider that substantial here means &#39more than 20%&#39. The basis for measuring whether a company&#39s non-trading purposes are capable of having a substantial effect varies according to the facts in each case but some or all of the following might be taken into account in reviewing a particular company&#39s status.

  • turnover receivable from non-trading activities,
  • the asset base of the company; and
  • expenses incurred by, or time spent by officers and employees of the company in undertaking its activities.

The Inland Revenue have confirmed in writing that cash is to be included in an asset base test. This means that falling foul of the “substantial effect” test cannot be avoided by merely leaving funds on deposit.

The effect of the company carrying out &#34excluded activities&#34 that would have more than a 20% (thus “substantial”) effect on the activities of the trade is that the shares qualify only for the less beneficial non-business assets taper relief. There is no mixed used test for shares: if one fails the business assets test all of the shares are non-business assets. Any shifts between business and non-business assets status are dealt with under the apportionment rules.


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