This week, I would like to focus on the relatively complex taper relief trap for company owners who make investments through their company. In considering the relative merits of investment bonds and collectives as corporate investments, I have referred to the negative impact on business assets taper relief that such investments can have. It is time to look at how the rules can operate.
Where a company has cash which will not be needed in the short to medium term, there may be an opportunity to consider its investment.
Subject to investment considerations and assuming the underlying funds reflect the investor's attitude to risk and requirements for income and growth, an asset-backed investment bond can offer tax advantages. As a non-income-producing asset, it does not provide a regular stream of taxable income and is relatively easy to administer. As it is asset-backed, it is likely to produce growth over the medium to long term and control can be exercised over the date of encashment and time of the tax charge.
But as corporate investors receive no credit for tax suffered by the life fund on income and gains when determining tax due on any chargeable event gains arising under UK bonds, these will not be appropriate from a tax standpoint. Offshore bonds offer more tax-efficiency.
Will such an investment have any impact on business assets taper relief? Two questions need to be asked. Will the investment have a substantial effect on the company's activities? Will it begin to carry on a business of holding investments? I will look at these in turn.
In broad terms, business assets taper relief is available for the appropriate period of ownership on all shareholdings in unquoted trading companies and all employee shareholdings in quoted trading companies in which they work. Shareholdings held by outside investors in quoted trading companies which carry at least 5 per cent of the voting rights also qualify.
For periods of ownership from April 6, 1998 to April 5, 2000, the test for shares is more restrictive but, as with the test for shares owned after April 5, 2000, a common theme is that the company must be trading. To complicate matters, from April 6, 2000, employees who own shares in a non-trading company in which they work can benefit from business assets taper relief provided that, broadly speaking, they do not own more than 10 per cent of the shares in the company.
Disregarding certain employees who hold shares in a non-trading company, for full business assets taper relief to be available, it is vital that the company is a trading company. This is defined in paragraph 22 of schedule A1 of the Taxation of Chargeable Gains Act 1992. A trade is anything which is a trade for income tax purposes and includes a profession or vocation. It must be conducted on a commercial basis with a view to the realisation of profits.
A trading company 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's activities.
The Inland Revenue's June 2001 tax bulletin gives guidance as to the meaning of “wholly” as follows: “In the context of the definition of a trading company, we would take 'wholly' to mean that the company had no purpose other than to trade. Wholly therefore means solely. Whether something is wholly for a trading purpose can only be considered in light of the requirements of the company's trade. One common situation is where a company sets aside funds and receives investment income. The fact that investment income is generated does not automatically lead to the conclusion that a company's purpose is not wholly trading.
“Whether the generation of income from investments is or is not evidence of a non-trading purpose must ultimately depend on the nature of the company's trade and whether the holding of the investment is closely related to the conduct of that trade. If it can be shown that holding any investment is integral to the conduct of the trade or is a short-term lodgement of surplus funds held to meet demonstrable trading liabilities, this is unlikely to be taken as evidence of non-trading purposes. For example, if a company has surplus funds which it intends to use for an expansion of the trading business in the near future, and it invests these in equities in the short term, it may be that the company's purpose continues to be wholly trading during the period those equities are held.”
If the purpose of the investment is to realise further cash that can be used to meet the company's trading requirements, including future expansion, it should not be regarded as having a substantial effect on its activities. What if the investment is not made to fund such a requirement? It is necessary to determine if the investment has a substantial effect on the company's activities.
The Revenue adopts a 20 per cent test which is explained by the bulletin: “The word substantial is used…to provide some flexibility in interpreting a section without opening the door to widespread abuse of a relieving provision. We consider that substantial here means more than 20 per cent. It is therefore necessary to consider what should form the basis for measuring whether a company's non-trading purposes are capable of having a substantial effect. We consider this will vary according to the facts in each case but some or all of the following might be taken into account in reviewing a particular company's status.” The Revenue lists three measures:
Turnover receivable from non-trading activities.
The company's asset base.
Expenses incurred by or time spent by officers and employees in undertaking its activities.
The Revenue has confirmed to us that cash is included in an asset base test so falling foul of the test cannot be avoided by leaving funds on deposit.