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16 October 2000
Whilst reading Taxation, specifically about taper relief on business assets, the activities of one of our clients sprang to mind. The wife (born September 1946) owns 52 per cent and the husband (born August 1950) 48 per cent of a manufacturing company. In March 1992 the company acquired freehold premises, and the value today would produce a gain exceeding indexation allowance. Our client contemplates retiring in five to six years' time.
Whilst reading Taxation, specifically about taper relief on business assets, the activities of one of our clients sprang to mind. The wife (born September 1946) owns 52 per cent and the husband (born August 1950) 48 per cent of a manufacturing company. In March 1992 the company acquired freehold premises, and the value today would produce a gain exceeding indexation allowance. Our client contemplates retiring in five to six years' time.
The freehold premises comprises two buildings: one (90 per cent of the area) is a factory and the other a house (10 per cent of the area). The house has been used to date for storage, as a drawing office and for administration.
Recently, an extra building has been added to the factory so that the house can be vacated. It is then intended that the company will let the house for residential use. It appears that turning the house from business to investment use might damage the taper relief that our clients might claim relative to their shares in their company, assuming that our clients sell up at that stage.
Do readers agree that taper relief will be affected by turning the house from business to investment use and, if so, what advice can be offered to alleviate this problem?
(Query T15,692) Taper.
Shares in an unquoted trading company owned by an individual shareholder qualify for business taper relief. A trading company means a company which either exists wholly for the purpose of carrying on one or more trades or would so exist 'apart from any purposes capable of having no substantial effect on the extent of the company's activities' (paragraph 22(1) of Schedule A1 to the Taxation of Chargeable Gains Act 1992). 'Substantial' is not defined in legislation but is generally taken to mean more than 20 per cent of turnover or capital employed (see the Revenue's Capital Gains Manual at paragraph CG62571 as applied to the enterprise investment scheme).
'Taper's' clients have the following three options available to them:
Do nothing. If the value of the house as an investment property is less than 20 per cent of the company's net assets, and the letting income is less than 20 per cent of turnover, retaining ownership of the house within the company will not restrict business taper relief. The disadvantage is that when the company is sold the shareholders may wish to retain ownership of the house or the purchaser may want to buy only the trading assets, so that the house has to be extracted from the company pre-sale. If the house appreciates in value, the tax charge could be significant.
Crystallise a capital gain now by transferring shares to an interest in possession trust to use retirement relief. Both shareholders are over 50 and, if they are full-time working directors or employees and have owned the shares for ten years, will qualify for full retirement relief. Retirement relief is being phased out but in the current tax year the maximum relief available for each shareholder is £375,000 (£150,000 at full rate and £450,000 at half rate). If a disposal is made whilst the house is used in the trade, there will be no restriction on retirement relief for non-business assets. A transfer into trust will restart the taper relief clock but, assuming a sale after four years, the trustees will be entitled to full business taper relief and have the benefit of a tax-free uplift from retirement relief.
Extract the house from the company now as a distribution. The disadvantage of this option is that it will create a capital gain in the company and an income tax charge on the shareholders. However, if the intention is to take the house out of the company before the shares are sold, it is better to do this now before the house appreciates in value as an investment property. — G.S.
Neatly restated, 'Taper's' question is 'do the shares in the company qualify for business asset taper relief and will they continue to do so after the proposed changes?'. It seems to me that establishing whether a company's shares satisfy the business asset taper rules is one of the most difficult aspects of this relief. There appears plenty of scope for confusion and error.
The fundamental tests are in paragraph 6 of Schedule A1 to the Taxation of Chargeable Gains Act 1992 as revised by Finance Act 2000. First the company must be a trading company and also, at least one of, the following must be satisfied:
the company is unquoted;
the shareholder making the disposal must be an employee;
the shareholder making the disposal must control at least 5 per cent of the votes.
From the information supplied, one must assume that this company is unquoted. I presume also that the husband and wife who own the shares work in it. There is thus no problem with the second test.
Is it a trading company though? Silly question! It is a manufacturing company. But look carefully. It must exist wholly for the purposes of carrying on a trade or must do so apart from purposes capable of having no substantial effect on the company's activities. What does 'substantial effect' mean? I, for one, am worried about this. Some commentators assume, apparently on the strength of a verbal comment from the Inland Revenue, that it will take the usual view of substantial. This is taken to be 20 per cent, drawn from the Revenue's interpretation of the enterprise investment scheme legislation — but this is in a different context. And, if it is 20 per cent, then 20 per cent of what — turnover, profits, capital employed?
We are not told, but must assume that the company presently only has its manufacturing trade. If so, then the shares should be a business asset from 6 April 1998 and there are no problems of apportionment with the rule change on 6 April 2000.
When the house is let, the company will have a trade and an ancillary property letting business (which is not a trade). There would appear to be no problem providing the property letting is not 'substantial', however measured.
One should be wary also of the anti-avoidance provisions in paragraph 11 of Schedule A1 to the Taxation of Chargeable Gains Act 1992. Where there is a relevant change in the activities of a close company, then the taper relief 'clock' is stopped at that point and starts running afresh. The commencement of holding investments is just such a change. It is questionable whether letting a property already held is a business of making investments. To some extent this is clarified by the Inland Revenue in its Capital Gains Manual at paragraph CG17919. Use of surplus funds of a trading company in certain ways does not amount to an investment business. These include:
letting part of the trading premises;
letting properties no longer required for the purposes of the trade, where the long term objective is to sell those properties.
So the present company is probably safe; failing all of which, it seems that the anti-avoidance provision in paragraph 11 can actually be reversed. To be caught, the company must be carrying on a business of holding investments at the time of the share disposal. It appears that ceasing the investment business before the share sale solves the problem.
I therefore conclude that business asset taper relief should be available. — The Snark.
The freehold premises comprises two buildings: one (90 per cent of the area) is a factory and the other a house (10 per cent of the area). The house has been used to date for storage, as a drawing office and for administration.
Recently, an extra building has been added to the factory so that the house can be vacated. It is then intended that the company will let the house for residential use. It appears that turning the house from business to investment use might damage the taper relief that our clients might claim relative to their shares in their company, assuming that our clients sell up at that stage.
Do readers agree that taper relief will be affected by turning the house from business to investment use and, if so, what advice can be offered to alleviate this problem?
(Query T15,692) Taper.
Shares in an unquoted trading company owned by an individual shareholder qualify for business taper relief. A trading company means a company which either exists wholly for the purpose of carrying on one or more trades or would so exist 'apart from any purposes capable of having no substantial effect on the extent of the company's activities' (paragraph 22(1) of Schedule A1 to the Taxation of Chargeable Gains Act 1992). 'Substantial' is not defined in legislation but is generally taken to mean more than 20 per cent of turnover or capital employed (see the Revenue's Capital Gains Manual at paragraph CG62571 as applied to the enterprise investment scheme).
'Taper's' clients have the following three options available to them:
Do nothing. If the value of the house as an investment property is less than 20 per cent of the company's net assets, and the letting income is less than 20 per cent of turnover, retaining ownership of the house within the company will not restrict business taper relief. The disadvantage is that when the company is sold the shareholders may wish to retain ownership of the house or the purchaser may want to buy only the trading assets, so that the house has to be extracted from the company pre-sale. If the house appreciates in value, the tax charge could be significant.
Crystallise a capital gain now by transferring shares to an interest in possession trust to use retirement relief. Both shareholders are over 50 and, if they are full-time working directors or employees and have owned the shares for ten years, will qualify for full retirement relief. Retirement relief is being phased out but in the current tax year the maximum relief available for each shareholder is £375,000 (£150,000 at full rate and £450,000 at half rate). If a disposal is made whilst the house is used in the trade, there will be no restriction on retirement relief for non-business assets. A transfer into trust will restart the taper relief clock but, assuming a sale after four years, the trustees will be entitled to full business taper relief and have the benefit of a tax-free uplift from retirement relief.
Extract the house from the company now as a distribution. The disadvantage of this option is that it will create a capital gain in the company and an income tax charge on the shareholders. However, if the intention is to take the house out of the company before the shares are sold, it is better to do this now before the house appreciates in value as an investment property. — G.S.
Neatly restated, 'Taper's' question is 'do the shares in the company qualify for business asset taper relief and will they continue to do so after the proposed changes?'. It seems to me that establishing whether a company's shares satisfy the business asset taper rules is one of the most difficult aspects of this relief. There appears plenty of scope for confusion and error.
The fundamental tests are in paragraph 6 of Schedule A1 to the Taxation of Chargeable Gains Act 1992 as revised by Finance Act 2000. First the company must be a trading company and also, at least one of, the following must be satisfied:
the company is unquoted;
the shareholder making the disposal must be an employee;
the shareholder making the disposal must control at least 5 per cent of the votes.
From the information supplied, one must assume that this company is unquoted. I presume also that the husband and wife who own the shares work in it. There is thus no problem with the second test.
Is it a trading company though? Silly question! It is a manufacturing company. But look carefully. It must exist wholly for the purposes of carrying on a trade or must do so apart from purposes capable of having no substantial effect on the company's activities. What does 'substantial effect' mean? I, for one, am worried about this. Some commentators assume, apparently on the strength of a verbal comment from the Inland Revenue, that it will take the usual view of substantial. This is taken to be 20 per cent, drawn from the Revenue's interpretation of the enterprise investment scheme legislation — but this is in a different context. And, if it is 20 per cent, then 20 per cent of what — turnover, profits, capital employed?
We are not told, but must assume that the company presently only has its manufacturing trade. If so, then the shares should be a business asset from 6 April 1998 and there are no problems of apportionment with the rule change on 6 April 2000.
When the house is let, the company will have a trade and an ancillary property letting business (which is not a trade). There would appear to be no problem providing the property letting is not 'substantial', however measured.
One should be wary also of the anti-avoidance provisions in paragraph 11 of Schedule A1 to the Taxation of Chargeable Gains Act 1992. Where there is a relevant change in the activities of a close company, then the taper relief 'clock' is stopped at that point and starts running afresh. The commencement of holding investments is just such a change. It is questionable whether letting a property already held is a business of making investments. To some extent this is clarified by the Inland Revenue in its Capital Gains Manual at paragraph CG17919. Use of surplus funds of a trading company in certain ways does not amount to an investment business. These include:
letting part of the trading premises;
letting properties no longer required for the purposes of the trade, where the long term objective is to sell those properties.
So the present company is probably safe; failing all of which, it seems that the anti-avoidance provision in paragraph 11 can actually be reversed. To be caught, the company must be carrying on a business of holding investments at the time of the share disposal. It appears that ceasing the investment business before the share sale solves the problem.
I therefore conclude that business asset taper relief should be available. — The Snark.
