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Tale of the taper

In concluding the rather tortuous but nevertheless important issue of how business assets taper relief can be denied in respect of gains arising on a sale of shares in a private company by virtue of the company making an investment, I would like to look at just how a company can “commence a business of holding investments”.

So, what does constitute the commencement of a business of holding investments?

In this respect, the Inland Revenue has advised us in correspondence as follows: “Whe-ther or not a close company commences carrying on a business of holding investments is a question of fact. The inspector considering the status of any close company would need to consider all the relevant facts in coming to a conclusion. In so doing, the inspector would not be applying any critical percentage to determine the issue.”

In its Bulletin, the Revenue considers what “business” is within paragraph 11(4) if a company is trading. It is stated that: “Companies that trade may also carry on a business of holding investments. It is however provided by para 11(6)(b) that such a business shall not be taken to include the placing of money on deposit, the holding of shares in 51 per cent subsidiaries and the making of loans to associated companies or participators.”

This means that if on the date of disposal of the shares the company only holds cash, there will be no restriction in business assets taper relief even though the previous ownership of non-business assets may have been such as to give rise to the business of holding investments. (This can be justified on the basis that when the company sells the investments, it may then suffer tax on any capital gains).

The Revenue goes on to state further: “We conclude from the above that activities which include holding investments in another company or making loans outside of the exceptions mentioned above may amount to a business of holding investments. However, where such activities are und-ertaken by a company which also carries on a trade, the trading context must be reviewed to establish whether a separate business of holding investments exists.”

Where a company carries on a trade, the question to ask is whether certain transactions are integral to that trade. This depends on the purpose for which a fund or asset is held.

“We can confirm that where a company does no more than invest funds surplus to its imm-ediate trading requirements, it will not be regarded as carrying on a business of holding investments under para 11(4) Sch A1. In consequence, neither the initial making of an investment with surplus funds, nor a change in the way the funds are invested subsequently, can constitute a relevant change of activity of the company within the legislation.” This paragraph has to be read in conjunction with the following paragraph.

“Where funds are, for the immediate future, surplus to current trading requirements, then the question will be whe-ther it can be shown that there will be a foreseeable need to use those funds in the trade in the future.

“If so, then it is unlikely that these will be part of a business of holding investments. If not, then the question has to be asked, at the time of the disposal of the shares, whether the company in question was carrying on a business of holding investments and, if so, whether there has been a previous time when it wasn&#39t or the business was small in comparison to the business at the time of the share disposal. Small, in this context, is taken to mean less than 5 per cent of the size that the business of holding investments has at the time of the disposal.”

Reading the two paragraphs together means that where a company has funds surplus to its immediate trading requirements, unless the company can show there is a foreseeable use for those funds in the company it will fall within paragraph 11 (4). If the company has a business of holding investments, will paragraph 11 apply to its shares? The Inland Revenue&#39s view is that: “Where the circumstances are such that the company has a business holding investments, there are a number of points to consider which may remove shares held in the company from the scope of paragraph 11.

First, the investing company must be a close company for paragraph 11 to apply. Second, paragraph 11(4) looks at the size of the business being conducted at the time of the disposal of the shares compared with an earlier period when the level of activity was small or non-existent.

Where a company has an ongoing and constant level of investment business, it is unlikely that para 11 will need to be considered. Para 11 is concerned with increases in the size of an investment business, measured with reference to 12 monthly periods rather than the existence of that business. Also, para 11 would not apply where the company&#39s business was not being conducted at the time of the share disposal.

The potential loss of business assets taper relief by making a corporate investment that infringes the rules adds substantially to the risk involved in making such an investment. Accordingly, any corporate investment (apart from satisfying the suitability and tax efficiency tests) must only be made after very careful consideration of the potential negative impact on business assets taper relief and what this may mean for the particular business being advised.

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