Tackling Taperitis!

KEVIN SLEVIN FTII, ATT, TEP explains why he is writing yet another article about taper relief, when it is supposed to be so simple.

THERE IS LITTLE doubt in my mind that if I state at this point just what this article is about, many readers will immediately form the view, almost certainly an incorrect view, that the subject matter is of little interest to them. So I will simply say that if you advise on capital gains tax and you do not read this article, you could be making a very big mistake.

In July 2002, it will be two years since paragraph 23 was inserted into Schedule A1 to the Taxation of Chargeable Gains Act 1992. All that time has passed by, but most readers will have yet to find time, or a reason, to study this significant taper relief provision. It could be at this point that you are thinking that it has not affected any of your clients because they do not hold shares in companies which have shares in joint venture companies. If so, you may well be suffering from a mild case of taperitis, an increasingly common condition within the taxation profession.

The most common symptom displayed by those suffering from taperitis is the belief that taper relief is straightforward. Those with an advanced stage of the condition, start to believe they understand how taper relief works. Fortunately, there are only a few known cases of the latter and there is a cure, or rather a course of therapy. Yes, the recommended therapy available to those afflicted by taperitis is to study paragraph 23.

Misleading title?

Paragraph 23 is entitled 'Qualifying shareholdings in joint venture companies', but the courts have held that such a title to a provision has little, if any, standing in law. In other words, one must read the provision ignoring any heading; only if the particular provision is ambiguous in some fundamental way can the taxpayer fall back on the heading for guidance. Indeed, it is best to read paragraph 23 free from any preconceived notions as to what it means, if one is to achieve a speedy understanding of it.

The first step is, therefore, to modify the phrase 'joint venture company' and substitute 'so-called joint venture company' in one's mind. This may sound pedantic, but it is not. When trying to take a grasp of the mechanics of paragraph 23, this less restricted view of things might help. The fact is that, while many companies with investments in joint venture companies will be affected by these provisions, many other company investments, not regarded by the interested parties as investments in joint ventures, will be affected too. In short, what this article is intended to demonstrate is that certain investments in the form of minority shareholdings made by a company can, in the right circumstances, have more effect on taper relief than other minority shareholdings held by it. In many instances, the outcome of paragraph 23 will go far beyond its intended impact.

Intended effect

In a nutshell, paragraph 23 is the Paul Daniels of the taper relief provisions. It can have the effect of transforming shares that would not otherwise qualify as business assets for taper relief purposes into shares that can so qualify. A company which is neither a trading company nor the holding company of a trading group can be transformed, as if by magic, so that its shares are converted into business assets, thereby benefiting its shareholders if and when they make a capital gain on the disposal thereof.

Translation time

Broadly speaking, all any reader needs to know about subparagraph 1 of paragraph 23 is that it says something along the lines of 'This paragraph changes everything you thought you understood about taper relief where the case under consideration concerns a disposal of shares in a company which has possessed shares in so-called joint venture companies at some time during the relevant period of ownership'. The foregoing is an over-simplification, but it is not far from the truth.

Simply put, subparagraphs 2 and 3 effectively say that a company has invested in a shareholding falling within paragraph 23 if, and only if, the shares in question are shares in a company which is either:

• a trading company; or
• the holding company of a trading group;

providing that:

• at least 75 per cent of its ordinary share capital is held by not more than five companies; and
• the investment comprises more than 30 per cent of the ordinary share capital of the company in question.

Note the absence of any reference to 'joint venture company' in this analysis, and note also that whether the shares in the so-called joint venture company be acquired by subscription or purchase etc. is of no relevance.

For example, PV Enterprises Ltd is a trading company with an issued share capital of 10,000 £1 ordinary shares held as follows:

In this simple example, both AB Ltd and AD Ltd can regard their investment in PV Enterprises Ltd as being special shareholdings for taper relief purposes, or, to be more precise, the shareholders in these two companies can do so at any point when trying to establish whether or not their shares in AB Ltd and in AD Ltd are business assets for taper relief purposes. Paragraph 23 has no application as regards the other shareholdings shown above.

Impact of joint venture shareholdings

The impact of so-called joint venture companies lies in subparagraph 4 which states that for the purpose of determining whether the investing company, i.e. the company which has invested in a so-called joint venture company, is a trading company:

(a) any holding by it of shares in the so-called joint venture company shall be disregarded; and

(b) the investing company, i.e. AB Ltd or AD Ltd in the example, is to be treated as carrying on an 'appropriate proportion' of the activities of the so-called joint venture company, or, where the so-called joint venture company is the holding company of a trading group, an appropriate proportion of the activities of that group.

At first sight, the impact of special shareholding status in respect of the shareholdings in PV Enterprises Ltd possessed by AB Ltd and AD Ltd is that, if the shares in either AB Ltd or AD Ltd would not otherwise rank as business assets within paragraph 4 of Schedule A1, by applying paragraph 23, the appropriate proportion of the activities of PV Enterprises Ltd is attributed to AB Ltd and AD Ltd. The 'appropriate proportion' means the proportion corresponding to the percentage of the ordinary share capital of PV Enterprises Ltd held by AB Ltd and AD Ltd, i.e. 34 per cent and 38 per cent respectively.

Having deemed the appropriate proportion (34 per cent) of PV Enterprises Ltd's entire activities to be carried on by AB Ltd, the shareholders of AB Ltd can re-examine the 'trading company' definition found in paragraph 22(1) (or, indeed, the 'holding company of a trading group' test) to see if the conditions are met taking into account the proportion of the activities actually carried on by PV Enterprises Ltd but deemed to be carried on by AB Ltd. AD Ltd's status can be re-examined in a like manner.

Let us take a simple example by assuming that AB Ltd does nothing else other than own 34 per cent of the shares in PV Enterprises Ltd. Ignoring paragraph 23, the shares in AB Ltd could not be regarded as business assets because (ignoring the rules for holding companies) for the shares to be business assets they must be shares in a 'trading company'. Trading company is defined by paragraph 22 as being either a company existing wholly for the purposes of carrying on one or more trades, or a company existing wholly for the purposes of carrying on one or more trades apart from purposes capable of having no substantial effect on the extent of [AB Ltd's] activities. If AB Ltd exists to hold shares in PV Enterprises Ltd, it is clearly not a trading company under the aforementioned definition. So far, so bad, i.e. without paragraph 23.

Paragraph 23, however, by allowing 34 per cent of PV Enterprises Ltd's activities to be deemed to be carried on as part of the purposes of AB Ltd, gives the shareholders in AB Ltd the possibility of demonstrating that AB Ltd is a trading company after all. All that is necessary is to show that either all the activities of PV Enterprises Ltd are trading activities, or that any non-trading activities carried on by it are insubstantial. Any reader who is not familiar with the meaning of 'substantial' in the context of taper relief, and the complexities arising therefrom, should not be starting from here. By disregarding the holding of shares in AB Ltd and attributing 34 per cent of PV Enterprises Ltd's activities to AB Ltd instead, fulfillment of the trading company conditions by AB Ltd will be possible.

Whether the deeming process laid down in paragraph 23 changes the status of AB Ltd will always be a question of judgment based upon the facts of each case. The above example is kept simple by assuming that AB Ltd does nothing other than own the shares in PV Enterprises Ltd, but in reality it is more likely that the trading company will have to be re-examined after pooling the actual activities, trading and non-trading, carried on by it with the activities deemed carried on by it under paragraph 23.

Holding company

Now, pre-supposing that AD Ltd has failed to satisfy the holding company of a trading group test without the magic that can be worked by paragraph 23, can paragraph 23 be used to deem the appropriate proportion of PV Enterprises Ltd's activities to be those of AD Ltd for purposes of establishing whether AD Ltd is a holding company (as defined)? The answer is to be found in subparagraph 5 which effectively states that for the purpose of determining whether the investing company, i.e. AD Ltd, is a holding company:

(a) any holding by it of shares in the so-called joint venture company shall be disregarded; and

(b) it, i.e. AD Ltd, shall be treated as carrying on an appropriate proportion of the activities of the so-called joint venture company (PV Enterprises Ltd in the above example), or, where the so-called joint venture company is the holding company of a trading group, of that group. It should be noted that this provision has no application to a holding in a 52 per cent subsidiary (as defined) the investing company.

Holding company of a trading group?

Here subparagraph 6 comes into play. It effectively states that, for the purpose of determining whether a group of companies is a trading group for taper relief purposes, and therefore whether the shares in the holding company thereof can be said to be shares in the holding company of a trading group:

• every holding of shares in the so-called joint venture company by a member of the group shall be disregarded; and
• each member of the group having such shareholdings shall be treated as carrying on an appropriate proportion (calculated by reference to the percentage of shares actually held by it) of the activities of the so-called joint venture company, or, where the so-called joint venture company is the holding company of a trading group, the appropriate proportion of that group's activities.

Subparagraph 6 cannot apply if the joint venture company is a member of the group.

Summary

When establishing whether the company in which shares are held (company A) is a trading company or the holding company of a trading group, it is always necessary to examine any shareholding which is not an investment in a 51 per cent subsidiary possessed by it in another company (company B) to establish whether the following three conditions are met:

• Does the shareholding owned by company A comprise at least 30 per cent of the ordinary share capital of the company in question and not more than 50 per cent thereof?
• Is company B a trading company or the holding company of a trading group?
• Is at least 75 per cent of company B's share capital held by not more than five companies?

If the answer to all three question is 'yes', then it is mandatory in considering the status of shares in company A for taper relief purposes:

• the shares held in company B are ignored; and
• the appropriate proportion of the company B's activities are imputed to company A.

Possible problem?

The potential difficulty is that there is no guidance as to how the activities deemed to be carried by a company (company A above) under paragraph 23 should be measured when examining the status of that company. It is possible to anticipate a situation arising where the mandatory impact of paragraph 23 is disturbing.

For example, let us assume that the activities of company A, ignoring paragraph 23, can be analysed, using the appropriate measure, as follows:

No one knows for certain what the appropriate measure is in any particular case, but assume for the purpose of discussion that the appropriate measure, ignoring the impact of paragraph 23, is turnover. Now assume that 45 per cent of company B's activities are automatically attributed to company A under paragraph 23, and that these comprise a mixture of trading and non-trading activities sufficient both in quantity and character to alter the balance between trade and non-trade activities in company A, such that the non-trade activities become substantial. Readers will say that surely this is not mathematically possible because paragraph 23 only attributes the appropriate proportion of activities from a company that is a trading company or the holding company of a trading group. If company B is a trading company, how can the proportion of its activities attributed to company A have anything other than a positive effect on company A's status?

The answer lies in the 'woolly' definition of trading company. It could well be that the 'appropriate measure' used in determining the trading company status of company B (say, capital employed) is different from the appropriate measure adopted in measuring the status of company A (turnover as stated earlier). There is no guidance as to how to mix and match the appropriate measures and it is not impossible to anticipate a situation where the deemed activities are analysed differently within company A than they were when concluding that company B was trading company.

Apart from this blip in the law, paragraph 23 should work effectively and may well do so in many more cases than the draftsman led us to think initially.

Kevin S Slevin is a tax partner with Solomon Hare in Bristol. He can be contacted on 0117 933 3000; e-mail kevin_slevin@solomonhare.co.uk.

Issue: 3851 / Categories: