Substantial or significant

Substantial or Significant?
Roger Jones BSc, FTII, TEP seeks guidance on a critical issue for taper relief purposes.
With the possible exception of IR35, capital gains tax taper relief seems to be occupying more column inches of the professional journals than any other topic at the present time. This is perhaps rightly so because, as many commentators before me have observed, following Finance Act 2000 it is inordinately complex. Unlike more esoteric reliefs, such as capital gains deferral under the enterprise investment scheme, it is also something which will affect virtually every tax professional sooner or later. Given the misapprehensions I have already encountered, I can only agree with the view expressed in Andrew Hubbard's article (Taxation, 10 August 2000 at page 485) that taper relief will be a source of many professional indemnity claims in due course. In fact, at least one major firm has made strong representations on this point to the Revenue already.
The trading test
Despite all that has been written, a fundamental point still troubles me. Suppose the manager of the local branch of the supermarket chain, Tesafebury plc, comes to see you. He has shares in the company, acquired through an option scheme several years ago. Not unreasonably he asks whether he will pay only 10 per cent tax if he were to sell the shares in a few years' time.
Cautiously checking paragraph 6 of Schedule A1 to the Taxation of Chargeable Gains Act 1992, and confirming that he is an employee of the company, you tell him 'yes if Tesafebury is a trading company'. 'Of course it trades', he retorts; 'what do you think the shops do?'. Nonetheless, he has with him a copy of the published accounts and you note that the company owns some rental properties and other investments. Can you give him an unequivocal answer?
The definition
Looking at paragraph 22 of Schedule A1, it will be found that a trading company means a company which is either:
'(a) a company existing wholly for the purpose of carrying on one or more trades; or
(b) a company that would fall in paragraph (a) above apart from any purposes capable of having no substantial effect on the extent of the company's activities.'
Tesafebury does not exist wholly for the purpose of a trade, but do its investments have a 'substantial' effect on its total activities?
Déjà vu?
At a quick glance, it might be thought that we have seen this test for a trading company before, but have we? The wording of the qualifying company test for enterprise investment scheme purposes in section 293(2), Taxes Act 1988 is similar but ends: ' apart from any purposes capable of having no significant effect (other than in relation to incidental matters) on the extent of the company's activities'. This applies for the capital gains tax deferral relief in Schedule 5B to the Taxation of Chargeable Gains Act 1992 and follows the old definition for reinvestment relief in the former section 164G of that Act.
But is there not a 'substantial' test in the enterprise investment scheme rules? There is indeed, but it is in a different place and means something different. Having once established that the company within the scheme exists to carry on a trade, etc., etc., section 297, Taxes Act 1988 lists any activity, or activities when taken together, which must not amount to a 'substantial part' of the trade. These activities are the disqualifying trades listed.
It is in this context that the Revenue's Inspector's Manual at paragraph 6997 suggests a 20 per cent test for the meaning of substantial. That is one step removed from 'does the company exist for the purpose of carrying on a trade'. The 20 per cent rule cannot be applied to the earlier rule in section 293. If there is an activity that is not a trade, one must ask oneself whether it has a significant effect on the extent of the company's activities (or whether it is merely incidental). Tax counsel has suggested to me that anything other than the most trivial (incidental) non-trading activities will in his opinion cause this test to fail.
The taper relief definition of a trading company is nearer to section 293 than section 297. It is unfortunate that the enterprise investment scheme legislation uses 'significant' and taper relief 'substantial'. If the words were the same, I would stop there and conclude that many investors will have a problem. In general English usage, I do not think that 'significant' and 'substantial' mean the same thing, so this is no real help.
Official pronouncements
The Revenue has given no official guidance on the meaning of substantial in this context, but there have been some notable statements:
(1) An article in Taxline March 1999, indicates that the Revenue has confirmed verbally that it may follow the enterprise investment scheme practice. However, it also takes the view that each case must be decided on its own facts and, initially, under self assessment it is for the taxpayer to decide whether the de minimis threshold is breached.
(2) More recently, (Taxation, 29 June 2000 at page 338) Tim Good muses on the lack of a published official view but reiterates verbal confirmation of the 20 per cent test.
(3) Perhaps surprisingly in view of the confusion exemplified in Andrew Hubbard's closing remarks (Taxation, 10 August 2000 at page 488), the matter does seem to have been addressed in the Committee Stage debates of the Finance Bill. Again the meaning of substantial had to be interpreted according to the facts of the case but 'in general' the Revenue took it to mean 20 per cent.
Percentages galore!
Is it right to take one specific application of 'substantial' as meaning 20 per cent to be the general view? Can one import this interpretation to a different definition in a different part of the legislation?
Practitioners may have observed 'small' in many places in the tax legislation. According to context, this means anything from 5 per cent to 20 per cent. If you want something a little nearer the mark, look at Inland Revenue Statement of Practice A8 where 'substantially' is interpreted as 15 per cent or more. In this light, can the adviser really be sure that substantial always means 20 per cent?
Or am I just being too cautious? Unless someone can give me convincing evidence to the contrary, I would still want to caveat advice to the Tesafebury manager very carefully.
Roger Jones is senior tax manager at Larking Gowen in Norwich, but the views expressed are personal and do not necessarily reflect the opinion of the firm.

Issue: 3779 / Categories: Comment & Analysis , IR35