What a Relief! Gifts of Business Assets

Ken Moody returns to basics and gives some ‘ins’ and ‘outs’ of ’gift relief’ (under TCGA 1992, s 165) and its relationship to entrepreneurs’ relief. 

If I were TCGA 1992, s 165 (‘Relief for gifts of business assets’) I might be feeling a bit neglected these days. Ever since that relative newbie, entrepreneurs’ relief (ER), hit the tax scene in 2008, section 165 gets much less attention (references in this article are to TCGA 1992). 

The ‘relief’ provided by s 165 applies only to a gift (or transfer at below market value) by an individual (although relief is extended to transfers by trustees by Sch 7, para 2), and basically enables any capital gain arising to be ‘held-over’ until the asset is disposed of by the transferee. 

The transfer of a chargeable asset either to a ‘connected person’ (e.g. a relative), or under a transaction which is not a ‘bargain made at arm’s length’, is deemed to be for a consideration equal to its market value (ss 17, 18). So the donor is liable to CGT even though he has received nothing with which to pay the tax – unless s 165 applies, or s 260 applies where the transfer is to trustees.

A ‘business asset’ for the purposes of s 165 is broadly as follows (s 165(2)):

a) an asset used for the purposes of a trade, profession or vocation carried on by the transferor (either solely or in partnership), his ‘personal company’ or a member of a trading group of which the holding company is his personal company, or

b) shares in an unlisted trading company, or in a trading company or holding company of a trading group which is the transferor’s ‘personal company’.

It will be immediately obvious that s 165 cannot apply to an asset used in a property letting business unless, exceptionally, the business is accepted as a trade. Furnished holiday lettings are deemed to be a trade for the purposes of s 165 and for certain other reliefs (s 241); and the legislation also includes the occupation of woodlands as being within the meaning of ‘trade’.

Relief is restricted where the asset in question was not used, or not wholly used, for the purposes of the relevant business for the whole period of ownership; and similarly, , in the case of company shares, relief may be restricted or denied if the company holds non-business chargeable assets or carries on substantial non-trading activities (see below). These aspects are not dealt with in this article.

Bob carries on a grocery business from a ‘lockup’ shop. He decides to retire and he gives the business to his son, Frank. The market value of the shop is £500,000 and there is no value in goodwill. The property cost £150,000 in 1995 and has been used wholly for the business throughout.  

Bob has a gain of £350,000, but he and Frank make a joint election to hold over the gain under s 165. 

Bob’s deemed proceeds are reduced by the held-over gain of £350,000 so he has no gain. Frank would acquire the property at market value of £500,000 but for the s 165 election, which is also reduced by the held-over gain of £350,000 so, in effect, Frank inherits Bob’s CGT base cost of £150,000.  

Relief may be restricted where actual consideration passes, which exceeds the transferor’s base cost.

The facts are as in Example 1, except that Frank pays £250,000 for the shop, which exceeds Bob’s base cost by £100,000 and relief is restricted to that extent. 

Bob’s gain is still £350,000, but only £250,000 may be held-over, and so Bob’s taxable gain is £100,000. Frank’s base cost is £500,000 - £250,000 = £250,000 which of course is the amount he has actually paid.   

In the case of a business asset consisting of shares, a holding of any size of shares in a company which is not listed on a recognised stock exchange may be the subject of a s 165 claim.  This would not include alternative markets, and so AIM listed shares may qualify. In most cases, the shares will be private company shares and so the alternative ‘personal company’ requirement (see b) above) would only be relevant in the very exceptional situation that the personal company requirement is met but the company is listed on a recognised stock exchange.

However, where the ‘personal company’ requirement is relevant is in relation to a hold-over election for an asset in use by such a company. A company is an individual’s personal company if he is able to exercise 5% or more of the voting rights (s 165(8)(a)). This is slightly different to the ER definition of the same expression which additionally requires the holding of 5% or more of the ordinary share capital. Another distinction which is important is that for ER as well as meeting the personal company test, the individual must be an officer or employee (s 169I(6)(b). This is not a requirement for s 165.

As noted, the company must be a ‘trading company’ or ‘member of a trading group’ as defined by s 165A, which definition is also used for the purposes of ER (s 169S(5)). It is beyond the scope of this article to explore these definitions in detail, but the activities of the company or group must not include ‘to a substantial extent’ activities other than trading activities. As many readers will be aware, the test of what is ‘substantial’ for the purposes of s 165 as well as for ER, is the subject of HMRC guidance in its Capital Gains manual (see CG64090) introducing a ‘rule of thumb’ of 20% by reference to various factors taken on balance. 

One important point to note in relation to shares is that s 165 does not apply if the transferee is a company. A further point is that, since 2004, relief is not available if the transferee is a settlor-interested trust. Such transfers used to be a useful way of ‘banking’ earlier CGT reliefs, such as retirement relief or taper relief, but are now ineffective for both s 165 and s 260.

In the introduction to this article, it was mentioned that s 165 is in some ways now a ‘poor relation’ to ER, especially in relation to incorporation of a business. Section 165 was sometimes used to hold over the gain on the transfer of the business to the company (a connected person), which was deemed to be at market value. However, the received wisdom is now to sell the business to the company at market value and credit the sale price to directors’ loan account (DLA). With the benefit of ER, the gain would be liable to CGT at only 10% (up to the lifetime limit of £10 million) and drawings may be taken from DLA in preference to remuneration or dividends liable to income tax (and NICs in the case of the former). 

However, take a situation where a business is a husband and wife partnership which makes taxable profits of £90,000 per annum. A company would pay salaries of, say, £8,000 each in order that the directors qualify for basic state pension credits without incurring National Insurance contributions, leaving £74,000 liable to corporation tax at 20% i.e. about £15,000. If the retained funds of £59,000 are distributed as dividends, while most of the couple’s personal allowances (£10,000 each for 2014/15) would be used against the salaries, the dividends received of £29,500 each, grossed up to about £33,000 each by the 1/9th tax credit, would be within the basic rate band. While there might be some goodwill value in the business there seems little point in paying CGT even at 10% in order to shore up a substantial DLA balance, where income drawings would not give rise to any income tax or NICs anyway. 

A s 165 election must be made using pages 9 and 10 of self-assessment helpsheet HS295. This contains the joint election under s 165 (or s 260) on page 9, and page 10 is an application to defer agreeing the market value of the asset (with HMRC Shares and Assets Valuation). Valuation of private company shares, in particular, is a notoriously arcane craft and there is little point in any such exercise if no tax is payable anyway. An estimated value is nevertheless required to be entered in order to complete the form, but this is in no way binding and ‘E’ should be entered after the figure where this is an estimate.