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In denial

Last week, I started my review of the difficult but important issue of the potential denial of business assets taper relief on a private company share sale by virtue of corporate investment. The value of the relief, potentially reducing tax on capital gains made on such share disposals to an effective rate of 10 per cent, makes its potential denial something to be concerned about.

The two main reasons for denial are that the company whose shares are being disposed of is not a trading company, because the investment has a substantial effect on the company&#39s activities, or that the company has begun the business of holding investments.

Last week, I began to look at the first of these reasons. In determining whether an investment by a company in, say, a single-premium bond or a collective investment has a substantial effect on the company&#39s activities, thereby impugning its trading status, a 20 per cent test appears to be used. On the question of 20 per cent of what – turnover, assets or expenses – is being measured, the Inland Revenue has commented as follows:

“The historical context of the company may be relevant. For example, it is quite possible that at an instant in time certain receipts may not be insubstantial but, if looked at on a longer timescale, they may. Looking at the historical context, therefore, a company might be able to show that it was a trading company at a particular point in time.

“It may be that some measures point in one direction and others in the opposite direction. We would weigh up the impact of each of the measures to balance the effects of measures that point in different directions in coming to a view. If, at the end of the day, the inspector was unable to agree the status of a particular company for a period, then this matter could only be ultimately established as a question of fact before the Commissioners. However, we anticipate that these cases will be relatively rare.”

If a taxpayer wishes to know whether a company is trading, he or she can ask the company or use their own judgement. Alternatively, the company can ask the Inland Revenue for a view on any accounting period.

The effect of the company carrying out excluded activities that would have more than a 20 per cent (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-use test for shares. If one fails the business assets test, all the shares are non-business assets. Any shifts between business and non-business assets status are dealt with under the apportionment rules.

The second important issue that can result in the denial of business assets taper relief is if the company has commenced the business of holding investments. The anti-avoidance provision in connection with this is contained in paragraph 11 of Schedule A1 TCGA 1992, which applies to close companies as defined in section 414 ICTA 1988, to prevent advantage being gained from activities designed to artificially increase taper relief.

This provision means that if there has been a relevant change of activity of the company between the date the shareholders acquired their shares (or April 6, 1998 if later) and the date of disposal of the shares, the period of time up to the relevant change of activity does not count for taper relief purposes.

In effect, should a change of relevant activity occur, the taper relief clock starts again from scratch from the time of the change, unless the company is prepared to sell all the investments and place the funds on deposit before the shares are sold.

A relevant change of activity will occur when either:

A company begins to carry on a trade, or

A company begins to carry on a business of holding investments or increases the size of that investment business.

Would the purchase of an investment, such as a single-premium bond, mean that a company begins to carry on a business of holding investments within the second of the criteria shown above, so that taper relief could be restricted? In answering this, it should be noted that paragraph 11(4) provides that there is a relevant change of activity (linked to a company being treated as commencing to carry on a business of holding investments) where:

At the time of disposal, the company was carrying on a business of holding investments, and

There has been any occasion falling within the 12 months up to the disposal, or any earlier period of 12 months ending after the acquisition of the asset or April 1998 6 if later, when the company was not carrying on the investment business or the size of the business was small by comparison with its size at the end of the period.

I will continue next week.

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