Peter Rayney begins this two-part article with a look at the capital gains tax entrepreneurs’ relief rules relating to ‘joint ventures’ prior to relaxations in the rules in Finance Bill 2016.
When determining whether a company qualifies as a ‘trading group member’ for entrepreneurs’ relief (ER) purposes, a corporate group is effectively treated as a single entity.
Background to original joint venture rules
Thus, where joint venture (JV) interests are held via a ‘51% plus’ subsidiary, this would have been treated as part of the group’s activities.
Different rules operate where a company/group has a ‘non-controlling’ interest in a ‘trading’ JV. This would be regarded as an investment activity under first principles. However, it was recognised that this would prejudice genuine trading relationships. Consequently, since April 2000, companies/groups with non-controlling interests in trading JVs were normally able to treat them as ‘transparent’ when testing whether the ‘trading’ company/group’ requirement had been satisfied for ER (and its predecessor, business asset taper relief). The assessment of a company’s ER trading status can be a subjective exercise. In many cases, the beneficial JV rules enabled the ‘investing’ company/group to be treated as carrying on the (relevant share) of the JV trade, thus enabling shareholders to benefit from ER on most share disposals.
Unfortunately, in recent years, HMRC perceived that these useful JV rules were being abused to access ER in certain ‘unintended’ cases, as illustrated in the example below:
Example – Use of JV rules to obtain ER for senior management following a secondary buy-out transaction
In December 2014, Cloud Nine Ltd acquired 100% of My Girl Ltd as part of a secondary buy-out transaction, with new equity funding being introduced by Gordy VC LLP and the senior management team.
There was insufficient residual equity for the senior management team to have ‘5% shareholdings’ in Cloud Nine Ltd (n.b. as to this 5% test, see the article ‘Entrepreneurs’ Relief: Watch Out For ‘Funny’ Shares! elsewhere in this issue). The five members of the senior management were therefore advised to form Williams Ltd to hold ‘their’ shares, with each member acquiring 20% of the equity and the voting rights of that company.
Under the original JV rules, 15% of the trading activities of Cloud Nine Ltd/My Girl Ltd (treated as one trading entity) would be attributed to Williams Ltd for the purposes of the ER ‘trading company’ test. This meant that the senior management team would be in a position to claim ER when Williams Ltd was liquidated after a subsequent sale of Cloud Nine Ltd (Williams Ltd’s sale of its 15% interest in Cloud Nine Ltd would qualify for the substantial shareholdings exemption, using similar JV attribution rules).
Abolition of beneficial JV provisions
The ability to obtain ER in such ‘contrived’ circumstances was ‘unacceptable’ as far as HMRC was concerned. Therefore, without any prior consultation, Finance Act 2015 completely abolished the ‘original’ JV rules for ER purposes (see TCGA 1992, s 169S(4A)(a)). Thus, in the above example, this meant that Williams Ltd (not having any other trading activity) would cease to be a trading company because its 15% interest in Cloud Nine Ltd would be treated as an investment.
However, like so often in fiscal law drafting, many commercial arrangements got punished because of the ‘sins of the few’! HMRC soon recognised that its total ban on ‘transparent’ treatment for JV’s would prejudice the ER treatment for those who held shares in companies with legitimate joint venture interests. To HMRC’s credit, it listened to the collective representations from the professional bodies, which resulted in Finance Bill 2016 introducing more carefully targeted JV rules.
We will explore the relaxations to the JV rules introduced by the Finance Bill 2016 in the July issue.
Note - This article is based on the current Finance Bill 2016, which may be subject to change before it receives Royal Assent.
