Last week, I started to look at how entrepreneurs’ relief can be affected by the investment of company money on deposit, especially as the financial pages are regularly telling us about the “cash hoarding” of companies (admittedly PLCs – but the same phenomenon could be relevant for some successful SMEs) and I thought it was a subject worth delving into.
The HM Revenue & Customs’ manuals have proved quite useful. The thing to avoid, it seems, is substantial non-trading activities. We are reminded there is no simple formula – and this is important, I think.
The issue will be looked at in the round and with consideration, where appropriate, given to three main tests – the assets test, the income test and the expenses test.
The most frequently cited are the assets and income tests and I looked at these last week. For both of these, broadly, a 20 per cent test is applied to determine substantial.
The other important indicator to consider (in addition to assets and income) is the level of a company’s expenses incurred, or time spent by officers and employees of the company, on trading and non-trading activities.
For example, if a substantial proportion of the expenses of a company were to be incurred on non-trading activities, then, on this measure, the company would not be a trading company.
Or a company may devote a substantial amount of its staff resources, by time or costs incurred, to non-trading activities. It is thought that for most genuinely trading businesses which have just accumulated funds from retained profits (whether they have actively invested them or not), the time/expenses incurred on any investment activity is likely to be very small to inconsequential compared with the time spent on running the business.
The company’s history may also be relevant. For example, at a particular instant, certain receipts may be substantial compared with total receipts but, if looked at on a longer timescale – for instance, if a company’s trade was seasonal – they may not be substantial compared with other receipts over that longer period.
Looked at in this context, therefore, a company might be able to show that it was a trading company over a period, even where that period may have included particular points in time when non-trading receipts amounted to a substantial proportion of total receipts.
This could be particularly helpful to a company that invests in an investment that delivers the taxable gain of income at the end of an investment period as opposed to on a year-by-year basis.
Perhaps one of the most reassuring observations made in the HMRC cpital gains manual is that the indicators discussed should not be regarded as individual tests to which a 20 per cent “limit” applies. They are factors, or indicators, that may be useful in establishing whether there is substantial overall non-trading activity. It may be that some indicators point in one direction and others the opposite way.
You should weigh up the relevance of each in the context of the individual case and judge the matter in the round (see the approach of the Special Commissioner in the inheritance tax case of Farmer and another (exors of Farmer dec’d) v IRC SpC 216). If you are unable to agree the status of a particular company for a period, then the issue could be established only as a question of fact before the First-tier Tribunal.
The importance of considering assets, income and expenses/time and attention cannot be underestimated. It would be too easy, and possibly too dangerous, to rely or focus too heavily on just one of the tests.
The assets test is the test most frequently quoted when considering the impact of corporate investment on entrepreneurs’ relief.
And while it is important, it is not necessarily the be all and end all. Having said that, if, as a matter of fact, the value of the investment made is less than 20 per cent of the overall value of the company’s assets, then it will be hard to see how this can be substantial.
Perhaps more fund-amentally, there also has to be some activity in relation to the “offending investment”. It would seem to follow then that merely leaving funds passively on deposit could, arguably, fail to count as an activity for the purposes of the legislation.
As stated last week, it would seem to be reasonable – and acceptable – to include the (proven) value of a business’s goodwill in the valuation for this purpose, even if it is not held on the balance sheet.
Next week, I will look at some frequently asked questions in relation to entrepreneurs’ relief and investments.