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Two capital gains tax reliefs have been surreptitiously curtailed, warns ANDREW GOTCH.
IN 6 APRIL 2003 two significant planning tools will suffer a change for the worse. This is a trap that has been in place since 1998, and many advisers will have forgotten that its jaws are slowly closing. In addition, new legislation in the Finance Act 2002 has had an adverse impact on a related area of more specialist interest.
Holdover relief
Two capital gains tax reliefs have been surreptitiously curtailed, warns ANDREW GOTCH.
IN 6 APRIL 2003 two significant planning tools will suffer a change for the worse. This is a trap that has been in place since 1998, and many advisers will have forgotten that its jaws are slowly closing. In addition, new legislation in the Finance Act 2002 has had an adverse impact on a related area of more specialist interest.
Holdover relief
On 6 April 2003 - less than one year away - the notoriously restrictive definition of 'trading company' that is used for taper relief, and which has attracted so much adverse comment from the professional world, will apply for the purposes of section 165, Taxation of Chargeable Gains Act 1992 (holdover relief for gifts of business assets) and for section 253 of that Act (relief for loans to trading companies). It will also apply for the purposes of the employee share ownership trust rules in sections 227 to 236 and share scheme planners should take careful note, although I do not consider those implications here. Quite why it was felt necessary to tighten up these relieving provisions in this way has never been explained - there is no intrinsic need for it and it seems to be another example of a gratuitous and misconceived restriction being imposed in the interests of legislative neatness.
At the moment, those sections both enjoy the reasonably relaxed definition of 'trading company' contained in paragraph 1 of Schedule 6 to the Taxation of Chargeable Gains Act 1992, which in effect applies a 51 per cent trading test ('wholly or mainly') to the company's business. However, the new definition will be that contained in the new paragraph 22A of Schedule A1 to the Taxation of Chargeable Gains Act 1992 which is that trading company means a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities.
As is well recognised, the presence of the weasel word 'substantial' means that taxpayers have to deal with a measurably increased level of uncertainty because, at least at the moment, the meaning of the word 'substantial' tends to be interpreted in line with the Inland Revenue's subjective view. Presumably from a starting point of saying that substantial is anything that is not insubstantial, this allows a 20 per cent measure - but 20 per cent of what? It could be assets, profits, turnover, activities: the only thing that is certain is that only a trading company with no surplus cash or non-business assets is unlikely to attract Inland Revenue scrutiny. In every other case, taxpayers and their advisers are on risk - and the stakes are high.
The practical effect of this tiny legislative change is that many taxpayers who are thinking of using section 165 to escape the onerous capital gains tax consequences of, for example, gifts of shares in trading companies to family members or trusts will have to act before the end of this tax year if they want to be certain that relief will be available. It follows that advisers should act now to make sure that this potential pitfall is to be circumnavigated.
Loans to trading companies
In the same way, taxpayers who have loans outstanding to trading companies or who have guaranteed the obligations of such companies will see their potential section 253 relief disappear if, at the time when the loan becomes irrecoverable or a payment under the guarantee is made, the company is not a trading company within the taper relief definition - even if it would qualify now. A review of such debts and guarantees is essential.
Incorporation and authors
The more specialised area affected by the Finance Act 2002 once again concerns section 165 holdover relief, and the point relates to authors.
The position of authors has always been slightly anomalous in tax terms, because any consideration derived from exploiting the products of their brains and word-processors is treated as income, even if copyright is assigned outright. The charge to capital gains tax that one might expect is precluded by section 37, Taxation of Chargeable Gains Act 1992 (consideration charged to income tax) even though the assignment of the copyright is clearly the disposal of an asset.
However, Mason v Innes [1967] 44 TC 326 established that because an author has no stock-in-trade, the decision in Sharkey v Wernher 36 TC 275 cannot be used to impute a market value for income tax purposes when copyright is gifted. There is no statutory market value rule for income tax and so in such circumstances there is no income tax charge and a capital gains tax charge is no longer precluded by section 37.
The up-shot is that if an author wishes to incorporate, the route to take is to gift the copyrights and claim relief under section 165, Taxation of Chargeable Gains Act 1992, because a transfer within section 162, Taxation of Chargeable Gains Act 1992 for a consideration in shares would generate an unrelievable income tax charge. (This assumes that copyright is an asset used for the purposes of the profession or vocation, of course, which in my view it is.)
However, following the introduction of the intangible asset rules in Schedule 29 to the Finance Act 2002, things have become a bit trickier. Paragraph 92 deems transfers of intangible assets (which includes copyrights) between related parties (usually the case in an incorporation) to be for market value for all purposes of the Taxes Acts where one party is a corporate body. Thus the market value whose absence prevented an income tax assessment in Mason v Innes suddenly appears, with the result that even a gift of copyright on incorporation gives rise to an income tax charge and section 165 is no longer in point. The effect of Mason v Innes is negated in such cases. Fortunately paragraphs 117 to 118 limit the application of the new legislation to copyrights created after 1 April 2002, but authors and their advisers need to consider very carefully the effects of this inconsistent treatment, particularly in the context of the current rush to incorporate.
Another interesting point for authors is that they cannot benefit from retirement relief. Any consideration they receive to cash in their retirement relief will be assessable as income - thus negating the relief. However, incorporation, while problematic, carries with it the possibility of achieving taper relief on shares that reflect the value of copyrights that an author would be incapable of selling as such in a way that attracted taper relief because copyright receipts are always income. So some financial pain now may be worth a greater benefit in the future - if the company remains a trading company, of course.
Andrew Gotch is a tax consultant for Professional Tax Practice Ltd. He can be contacted on 01865 847474.
