More Tinkering With Taper

KEITH M GORDON MA, ACA, ATII considers the effects of the recent changes to the definition of business asset for taper relief purposes.

'To tax and to please … is not given to men' according to Edmund Burke (1729-97) in his work On American Taxes. This perceptive remark was again proved to be correct on the introduction of taper relief.

Capital gains tax was given the radical overhaul that many commentators claimed was long overdue by the Finance Act 1998. However, when taper relief replaced indexation, not everyone was happy. The harshness of some of the new rules was alleviated in section 67, Finance Act 2000, and again in Schedule 26 to this year's Act.

Central to these changes is the definition of 'business asset' which determines whether or not a taxpayer may enjoy the enhanced rate of taper relief. This article looks at how this definition has changed, and also at the consequences of a disposal of an asset subject to the changing rules.

Assets other than shares

The rules defining what constitutes a business asset distinguish between shares and other assets. Assets other than shares are considered in paragraph 5 of Schedule A1 to the Taxation of Chargeable Gains Act 1992.

The original definitions in Finance Act 1998 were revised in Finance Act 2000, but these amendments only took effect from 6 April 2000, so in many cases it is necessary to apportion gains realised on assets held on this date in accordance with the rules detailed below. Further amendments were made to the definitions in Finance Act 2001, although these rules were backdated to 6 April 2000 to align them with the Finance Act 2000 changes.

If an individual disposes of such an asset, that asset is a business asset provided that it is used for the purposes of:

• a trade carried on at that time by that individual or by a partnership of which that individual was at that time a member; or
• any trade carried on by a company which at that time was a qualifying company by reference to that individual; or
• any trade carried on by a company which at that time was a member of a trading group the holding company of which was at that time a qualifying company by reference to that individual; or
• any office or employment held by that individual with a person carrying on a trade (paragraph 5(2)). Until April 2000, there was a test requiring the individual to be a full-time working officer or employee or to devote substantially the whole of his time to the office or employment.

The definition of 'qualifying company' in respect of individuals is found in paragraph 6(1) and (1A). It should be noted that the definition can, in some instances, be independent of the individual making the disposal. In particular, if the company is an unlisted trading company, it will be treated as a qualifying company notwithstanding the asset being disposed of.

That gives rise to the anomalous situation that investment property rented out to an unlisted trading company has since 6 April 2000 qualified as a business asset. An investment property rented out to a trading partnership, however, will not so qualify, unless the individual is a member of the partnership.

For disposals by trustees, an asset is a business asset at any time if it is used for the purposes of:

• a trade carried on at that time by the trustees or (from 6 April 2000) by a partnership of which one or more of the trustees (in that capacity) was at that time a member; or
• a trade carried on at that time by an eligible beneficiary or by a partnership of which an eligible beneficiary was at that time a member; or
• any trade carried on by a company which at that time was a qualifying company by reference to an eligible beneficiary or the trustees; or
• any trade carried on by a company which at that time was a member of a trading group the holding company of which was at that time a qualifying company by reference to an eligible beneficiary or the trustees; or
• any office or employment held by an eligible beneficiary with a person carrying on a trade (paragraph 5(3)). Until April 2000, there was a test requiring the eligible beneficiary to be a full-time working officer or employee or to devote substantially the whole of his time to the office or employment.

The definition of 'qualifying company' in respect of trustees is found in paragraph 6(2) and (2A). An 'eligible beneficiary' is defined in paragraph 7 as:

'any individual having at [the relevant] time an interest in possession under the settlement in either–

This is provided that the interest is neither:

• a right under the settlement to receive an annuity; or
• limited to a fixed term unless the individual with that interest will become entitled to the property at the end of the fixed term.

For disposals by personal representatives, an asset is a business asset at any time if it is used for the purposes of:

• a trade carried on by the deceased's personal representatives; or
• any trade carried on by a company which at that time was a qualifying company by reference to the deceased's personal representatives; or
• any trade carried on by a company which at that time was a member of a trading group the holding company of which was at that time a qualifying company by reference to the deceased's personal representatives.

Shares

The rules defining when shares constitute business assets are considered in paragraph 4 of Schedule A1.

Essentially, the status of the shares depends on whether the company is a qualifying company in respect of the person(s) making the disposal. However, until 5 April 2000, shares only qualified as business assets in respect of personal representatives if:

• the company was a trading company (or the holding company of a trading group); and
• the personal representatives had 25 per cent or more of the voting rights in the company.

Qualifying companies

It is here that the changes have been most apparent. As will have been seen above, the definition of 'qualifying company' is relevant to both shares and other assets. However, whereas not all non-shares rely upon the definition, its meaning is crucial when it comes to ascertaining whether shares are eligible for business asset taper relief.

The various definitions are set out in Tables 1, 2 and 3, and show how the rules have changed since April 1998 depending on whether the assets are being disposed of by an individual, by trustees or by personal representatives.

The Finance Act 1998 rules were narrowly drafted and generally required a trading company and a five per cent shareholding for an employee to qualify for business asset taper relief, and a 25 per cent shareholding for anyone else.

Finance Act 2000 expanded the definition of trading company to allow all employees of trading companies to qualify for the enhanced taper relief given to business assets and owners of shares in unlisted trading companies to qualify, whether or not they were employees. The old 25 per cent threshold was substantially reduced to five per cent applying now just to non-employees of listed companies. However, since the new definitions only apply from 6 April 2000, taxpayers who acquired shares shortly before that date may be in a worse tax position (and suffer more complex calculations) than someone who acquired the shares after that date. However, these anomalies can be overcome if disposals are triggered now (perhaps by gifting the shares into a trust).

While the Finance Act 2000 changes favour employees of trading companies, former employees of such companies now find themselves in a worse tax position if they retain their shares once they leave employment. Considering only the tax position, such employees will be best advised to trigger a gain on departure from their company.

The Finance Act 2001 changes were in particular designed to assist employee shareholders. In view of the difficulty of ascertaining whether or not the company is a trading company, the new rules allow most such employees to claim business asset taper relief in respect of the shares irrespective of the company's trading status.

The rules are subject to a 'material interest' test in order to prevent abuse of the changes, for example, private investment companies attracting business asset taper). 'Material interest' is fully defined in new paragraph 6A but broadly means 'possession of, or the ability to control' ten per cent of the issued shares or voting rights of the company.

Material interest is based upon the interest of:

• the person(s) disposing of the shares, X; or
• X together with one or more persons connected with X; or
• any person connected with the X, with or without any other such persons (paragraph 6(4) and (5)).

'Connected' has the meaning given in section 286. It is not immediately clear what the third leg of this test achieves since the interest of any person(s) connected with the person disposing of the shares ought to be taken into account when applying the second leg. However, it does make explicit that the material interest test will bite if a connected person on his own holds more than ten per cent of the shares or voting rights.

Computation of a gain

When a chargeable asset is disposed of, a gain is calculated by deducting any cost from the net sale proceeds. For assets acquired before April 1998, indexation allowance will also be available leaving a net gain before taper relief. For many disposals, taper relief will simply be calculated by considering the qualifying period of ownership. This is the period up to the date of disposal which commences on the later of 6 April 1998 and the actual acquisition date

However, this is subject to the anti-avoidance provisions in paragraphs 11 and 12 of Schedule A1 and the bonus year given to non-business assets acquired before 17 March 1998 (section 2A(8)).

For assets that are treated as both business assets and non-business assets during the period of ownership, an apportionment is necessary. This can happen if the assets are put to different uses at different times or (as will be likely in many cases) the definition of business assets changed with effect from 6 April 2000 and so an apportionment is required for the periods either side of this date. It is important to remember that the apportionment only applies to the net gain before taper relief, the rate of taper relief is calculated according to the aggregate period of ownership. See Example 1.

If the asset was acquired before 17 March 1998, then the bonus year may be in point for the non-business part of the disposal. See Example 2.

It must be remembered that for such apportionments as in Example 2, one should look at the relevant period of ownership (as above). However, if this period is longer than ten years, then only the last ten years are relevant (Schedule A1 paragraph 2(2)). See Example 3.

Keith Gordon is a director of ukTAXhelp Ltd and can be contacted by e-mail on keith.gordon@ukTAXhelp.co.uk. The views expressed in this article are those of the author.

Issue: 3820 / Categories: