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Home > Regulation > UK Regulation

By Jeremy Pearson | Published May 23, 2012

Measuring up

From time to time, advisers may be asked about the tax aspects of corporate investment. A company may have spare cash, not particularly needed for business purposes in the near future, and may be looking for a tax-efficient home for it. If so, then you must consider the important issue of entrepreneurs’ relief.

Of course, you must first consider the issues of the need for the company to have access to cash, taxation of the gains and income and the directors’ attitude to risk. But you would not want to recommend a strategy that would adversely impact upon the availability of entrepreneurs’ relief. After all, a capital gains tax rate of only 10 per cent on qualifying gains of up to a cumulative £10m means that it is a relief worth preserving. To put it at risk, possibly inadvertently, would be an absolute disaster.

One of the key qualifying conditions for entrepreneurs’ relief is that, when disposing of shares in a company, it must be a trading company. Trading company in this context means a company carrying on trading activities, which does not have non-trading activities to a substantial extent. So we need to consider what is “substantial” in terms of “non-trading” activities.

The HMRC manual is most helpful on this subject. It starts by reminding us that most companies and groups will have some activities that are not trading activities. The legislation provides that entrepreneurs’ relief still applies if their activities “...do not include to a substantial extent activities other than trading activities”. The phrase “substantial extent” is used to provide some flexibility in interpreting a provision, without opening the door to widespread abuse. Substantial in this context usually means more than 20 per cent.

The question to ask is how should a company’s non-trading activities be measured to see if they breach this limit? There is no simple answer to this but some, or all, of a number of factors are among the measures or indicators that might be taken into account:

1. Income test

The income test is one of the so-called indicators. For example, a company may be trading, but also lets an investment property. If the company’s receipts from the letting are substantial in comparison to its overall income then, on this measure in isolation, the company would probably not be a trading company. The same could be true if the company had investments that yielded dividends and these were substantial in relation to its trading income.

But what if the company invested in non-income producing assets through the medium of growth-based collective investments or an investment bond? Well, if the company was a small company taxed under the historical cost accounting rules, it would seem that in those circumstances the “income” indicator would be redundant until some income was produced. (Remember that the investment bond chargeable event rules do not apply to companies.) In this respect it is also worth considering the overall “history” of the company - see later.

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