Taxation logo taxation mission text

Since 1927 the leading authority on tax law, practice and administration

Casebook - Pointless Questions

06 November 2002 / Paul Aplin
Issue: 3882 / Categories:

As the saying goes, if you do not ask, you do not get, and this is true even for obtaining enterprise investment scheme relief, says PAUL APLIN.

CHANCELLORS OF THE Exchequer are, probably by definition, kill joys. Do you remember, for example, how the nursery rhyme

As the saying goes, if you do not ask, you do not get, and this is true even for obtaining enterprise investment scheme relief, says PAUL APLIN.

CHANCELLORS OF THE Exchequer are, probably by definition, kill joys. Do you remember, for example, how the nursery rhyme

'Old Macdonald had a farm,
E-I-E-I-S'

was ruined when Finance Act 1998 removed farming from the list of trades qualifying for relief under the enterprise investment scheme? Section 297, Taxes Act 1988 has not been the same since.

Two recent experiences provided reminders of the importance of fully exploring apparently hopeless enterprise investment scheme cases. The first case centred on a fundamental enterprise investment scheme problem: to qualify, the company must carry on a qualifying trade or trades. With exquisite perverseness, section 297 defines a qualifying trade as one that does not consist to any substantial extent of one or more of the activities listed in subsection (2). The listed activities are those regarded as so low risk that they need no fiscal generosity. One such is farming.

Bleak prospect

Mr Bleak and Mr Prospect came into the office one morning last year. They were directors of Wondercrops Farming Ltd and wanted to discuss enterprise investment scheme relief. It looked like being a short meeting. Apparently they had already applied for relief and had been turned down. The trade description on the form EIS 1 they produced seemed pretty clear: 'growing and selling crops'. When told that farming had not been a qualifying trade since 16 March 1998, they looked at each other and began to put their papers away. It seemed polite to ask exactly what the company did.

'Well,' said Mr Prospect, 'we deal in a special crop. We buy it in from growers, process it and sell it on to end markets. We also grow some of it ourselves, for research. One of the research crops is overseas. It has some pretty interesting end uses, as you can see'. He slid a sales brochure across the table. It was fascinating and the case was looking less hopeless by the minute.

More promising

The statutory definition of farming is set out in section 832(1), Taxes Act 1988:

'Farm land means land in the United Kingdom wholly or mainly occupied for the purposes of husbandry, but excluding any dwelling or domestic offices … and farming shall be construed accordingly.'

The overseas activity clearly fell outside the definition. There was a danger that it might cause the company to fail the 'carried on wholly or mainly in the United Kingdom' test set by ibid., section 289, but Inland Revenue Statement of Practice SP3/00 confirmed that the test operated at the 50 per cent level. Having removed the non-United Kingdom element, could we remove more? The Revenue's Inspector's Manual at paragraphs IM2253 to 2263 helpfully breaks down the definition into its elements. Farmland let for a period of 365 days or more (it says) is generally regarded as occupied (and therefore farmed) by the tenant, and if let for a period of less than 365 days, the landowner will normally be deemed to be the occupier (and therefore the farmer). Share farming is acknowledged to be a difficult area. Contract farmers are not regarded as farming, the owner of the land they contract farm is. Finally there is the question of husbandry. The Manual refers to the dictionary definition and, very helpfully indeed, to a case relating to processing: Commissioners of Inland Revenue v Cavan Central Co-operative Agricultural and Dairy Society Ltd 12 TC 1.

The Cavan case related to milk products, but the principle was clear: processing is not farming. By chipping away at the various elements of the definition, we had managed to reduce the activities defined for tax as farming to well below 20 per cent of the overall activities, the 'insubstantial' level given in the Revenue's Venture Capital Schemes Manual at paragraph VCM17040. The hopeless case had turned good. Mr Prospect was by now smiling broadly, but Mr Bleak apparently still had something on his mind.

What about fish?

'Just out of interest, would a fish farm qualify?'

The Inspector's Manual at paragraph IM2260b supplied the answer, namely yes. As long as the fish are kept entirely separate from the land occupied by the person carrying on the activity (in tanks) and fed entirely on purchased feed, the activity is not farming. The paragraph goes further, saying that agricultural buildings allowance will be available on the tanks. Mr Bleak was now smiling too; he really should consider changing his name.

Both businesses, each at first glance farming, subsequently secured enterprise investment scheme status. A similarly systematic approach can yield results when looking at the other excluded trades.

Potential money spinner

A few weeks later four people came in to discuss a new business venture. The bank had asked them to prepare profit and cash flow forecasts and had kindly recommended us. The business had great potential and they felt they would be in a position to sell it at a considerable profit in three to four years. The number crunching would be pretty straightforward, but had they considered the tax aspects? Did they know about enterprise investment scheme? Mr Black, Mr and Mrs Green and their son Harry seemed to find the prospect of tax savings rather more interesting than the cash flows they had initially come to talk about.

Was there any possibility of finding more investors? There was, as it happened, but the four would not want to lose control of the business. They would consider one additional investor if necessary. Sadly, it was not enough. Section 291(1)(b), says that an investor cannot qualify if 'he is … at any time in the relevant period connected with the company'. The rest of section 291 and sections 291A and 291B set out the notoriously wide definition of connected persons. The particular problem in this case was section 291B(1), which treats a person as being connected with a company if, together with his associates, he owns, inter alia, more than 30 per cent of the share capital. Associates are defined at section 312(1) as being those listed in section 417(3) and (4), excepting brothers and sisters from the list of relatives, leaving: 'husband or wife, parent or remoter forebear, child or remoter issue' together with the various business and trust associates. Mr Green, Mrs Green and Harry would thus be associated for this purpose. More than one extra investor would be needed, and this was not acceptable.

Chink of light

Shortly after they had left (Butterworths Yellow Tax Handbook having just been flung across the room in frustration), Harry rang on his mobile. He said he did not know whether it would make any difference, but there was something he felt he should add. He said that he was Mr Green's son by his first marriage and Mrs Green's adopted son. The Venture Capital Schemes Manual, at paragraph VCM25200 says that relatives other than husband and wife 'should be regarded as associated only if there is a blood relationship; for example, an illegitimate child is an associate but a step child is not'. The company could therefore be structured with Mr Black, Mrs Green and Harry owning just under 30 per cent each and with the additional investor (a Mr Brown, you will not be surprised to hear) holding just over ten per cent.

The interpretation was checked over the telephone with the (as always very helpful) Small Companies Enterprise Centre, and the relationships were explicitly set out in the advance assurance letter.

The total income tax relief secured amounted to just short of £100,000. The tax-free gain is awaited with anticipation. The cash flow is long forgotten.

Not so pointless

These were two seemingly hopeless cases, but both turned out well. Which just goes to show that apparently pointless questions can often produce startling answers, especially where the enterprise investment scheme is concerned.

 

Paul Aplin is a tax partner with A C Mole & Sons, and can be contacted on tel: 01823 251311, e-mail: paulaplin@acmole.co.uk.

 

Issue: 3882 / Categories:
back to top icon