Peter Rayney looks at a recent tax tribunal decision on the trading status of a company for entrepreneurs’ relief purposes.
We can take some comfort from a recent ruling on trading status for entrepreneurs’ relief (ER) purposes. The recent First-tier Tribunal decision in J and N Potter v HMRC [2019] UKFTT 554 appears to be the first reported case to examine a company’s status for ER purposes.
Non-trading activities
One of the conditions for ER on share sales and company liquidation distributions is that the relevant company must be a qualifying trading company or holding company of a trading group during the relevant period. Broadly, the law requires the company or group to be wholly trading. However, a company/group can have some non-trading (typically investment) activities without affecting its qualifying status, provided the element is not ‘substantial’.
In practice, HMRC accepts this ‘de minimis’ rule is satisfied where the ‘non-trading’ element does not exceed 20% of the total activities. HMRC guidance indicates that a range of measures should be used in reviewing this test – being income/sales, gross assets, expenses incurred, employee and management time, as well as the company’s history (see HMRC Capital Gains manual at CG64090).
The facts in Potter
HMRC refused Mr and Mrs Potter’s ER claim on their (capital) liquidation distributions made on 11 November 2015 on the grounds that the company ceased trading in 2009. Consequently, HMRC argued it was not a trading company throughout a one-year period (since 6 April 2019, the relevant period is two years) ending within three years of the capital distribution (as required by TCGA 1992, s 169I(7) – Condition B).
The Potters’ company – Gatebright Ltd - had traded successfully as an introducing broker and dealer on the London Metal Exchange. However, its business all but collapsed during the 2008 credit crunch and it issued its final invoice in 2009. Mr Potter still tried to revive the business and continued to work his network of contacts despite losing his regulatory licences, but there was little appetite for investment, and he had various personal problems.
When the trade collapsed in early 2009, the company applied a large part of its reserves in acquiring £800,000 worth of six-year investment bonds, leaving some £200,000 cash for working capital.
Despite Mr Potter’s efforts, it was decided to wind the company up in June 2015, and the Potters claimed ER on their capital distributions (as summarised above).
Reasoning for decision
Although the tribunal judge said this was a finely balanced case, she accepted Mr Potter’s evidence that the company had satisfied the trading company requirement up to at least November 2012. Therefore, ER was available on the Potters’ November 2015 capital distributions.
Mr Potter’s continued efforts demonstrated that the company was seeking to revive the company’s trade. The judge accepted Mr Potter’s observation that If the shop is open, but nobody buys anything, it does not change its business classification, but only up to a point. She expressed the view that when there is no realistic possibility that efforts to drum up business will lead to future trading transactions, “it can no longer be said that the trading activities are being carried out for the purposes of a trade…At that point, the company must cease to be a trading company”.
Another interesting feature of the judgment was the finding that the purchase of the investment bonds did not violate its ER trading status under the substantial ‘investment’ activity rule in TCGA 1992, s165A(3). After 2009, the company’s main asset was the investment bonds and its sole annual income was the £35,000 interest, which pointed to ‘investment’. However, it had virtually no activities relating to the bonds and was trying attempting to revive its trade in an adverse economic climate – its activities were focused on trading.
