‘Trading’ activity and tax – when can company owners claim CGT and IHT reliefs?

Thursday, July 26, 2012 | Posted by: Mike Hyland
Categories: Business, Personal, Protecting your wealth | Tags: tax, capital gains tax, inheritance tax, CGT, IHT, Mike Hyland, shares, sale, BPR, Entrepreneurs' Relief, Business Property Relief, Entrepreneurs’ Relief, non-trading assets, holdover relief, company sale, HMRC clearance, trading company, trading status, investment assets

There are a number of reliefs that can help company owners mitigate capital gains tax (CGT) on selling or giving away their shares, and inheritance tax (IHT) on their death or on a gift into trust. A general requirement for all of these reliefs is that your company or corporate group must be ‘trading’. Here I’ll explore what this means and how the position might be optimised.

CGT reliefs
The two key reliefs applicable to CGT are holdover relief for gifts of business assets and entrepreneurs’ relief.

Both of these reliefs require your company or group to be carrying on trading activities, and not carrying out activities other than trading to a ‘substantial extent’.

Substantial extent has no statutory definition but is generally considered by HM Revenue & Customs (HMRC) to mean non-trading activities amounting to more than 20% of the total activities. This 80/20 test is most frequently measured in terms of the asset base of the company, its turnover, and/or the expenses incurred and time spent by officers and employees of the company on non-trading activities, although other measures can be considered.

These factors are viewed ‘in the round’ taking account of the nature and appropriateness of each measure to the company or group. Therefore, having non-trading activities which amount to more than 20% on the basis of any one measure is not necessarily fatal to a claim for relief.

Trading status is often in doubt where excess cash is retained or is invested in non-trading assets, such as investment property. While an investment property is clearly a non-trading asset, cash on the balance sheet is a grey area, since a certain level will be required as working capital. In this case, the company should record the reasons for holding high levels of cash, for example: are the directors looking to fund expansion into new premises or are there potential future liabilities, such as a pension fund deficit or a project to fund?

There is a potential further restriction, in the case of holdover relief, where shares are gifted in a company that holds non-business assets. Therefore, it is important to take advice before making gifts of shares where this relief is to be relied on to mitigate CGT liabilities.

In the case of entrepreneurs’ relief, no further restriction is applied where non-business assets are held, and full relief is available once the trading test has been met (subject to the usual conditions for entrepreneurs’ relief which are not considered here).

Business property relief from IHT
100% relief from IHT is available on ‘qualifying shareholdings’. The initial test for business property relief (BPR) is somewhat less stringent in terms of the trading requirement. To be eligible, a company’s business must not consist ‘wholly or mainly’ (ie more than 50%) of investment activities.

How is the ‘wholly or mainly’ test applied? It’s looked at in the round, with consideration of the asset base of the company, turnover, profit, time spent by employees and the overall context of the business.

However, there is a further hurdle after the ‘wholly or mainly’ test. Where a company holds ‘excepted assets’ – those neither used wholly or mainly for the purposes of the business nor required for the future use of the business – the BPR available is restricted by their value. Again, excess cash and investment assets can be in issue here, if they can’t be seen to form part of the company’s business.

How can I optimise my position?
It is always sensible to seek advice at an early stage when contemplating any transaction that could have significant tax consequences. This will give you more time to take any necessary actions to preserve the above reliefs.

It’s also worth noting that, in some cases, an advance view or clearance may be obtainable from HMRC regarding the trading status of a company where this is in doubt. Where clearance can be obtained, this allows for certainty as to the availability of relief or time for remedial action before the proposed transaction.

Finally, there are several tax planning ideas that can potentially allow the above reliefs to be accessed, even where the company or group appears to hold significant investments – and this can lead to large tax savings on valuable shareholdings.

Visit our Private Client and Wealth Management page for further help and information.

You might also find these posts useful:

* 10 tax considerations when selling your company
* Avoiding inheritance tax with business property relief? Beware these nightmare scenarios…
* Read more posts by Mike Hyland