Points of view

KEY POINTS

• The 'statutory fiction' to make entrepreneurs' relief work.
• When is a disposal 'associated'?
• Associated disposals and 'withdrawal from participation'.
• Conflicting views of HMRC's examples.
• How much of a delay is allowed in a delayed sale?

The article by Mark Morton regarding HMRC's guidance in their Capital Gains Manual on capital gains tax entrepreneurs' relief (Conflict of views) was naturally of great interest to me.

I felt that his views might be a little harsh, but I am sure that HMRC are well able to argue their corner; after all, it is not my job to leap to the defence of HMRC but the phrase 'damned if they do, damned if they don't' springs to mind.

However, I decided that, as the article was entitled Conflict of views, it would not be inappropriate to pen a few words as to why I disagree with some of Mark's points. I am not saying that his analysis is technically defective, rather that I am looking differently on HMRC's attempt to explain the position to their staff.

The first point made by Mark concerns partnerships. The position of partnerships within TCGA 1992 (to which all other statutory references in this article relate) is no better than it was in FA 1965 when capital gains tax was introduced.

It is only thanks to the sterling work of the various professional bodies in the late 1960s and early 1970 which resulted in what we read today as SP/D12, the Statement of Practice on partnerships, that transactions arising out of individuals being in partnership can be made to fit easily within the capital gains tax provisions.

However, Mark highlights the fact that the entrepreneurs' relief provisions contain special provisions to make this new legislation work as regards partnerships.

Partnerships

I will not repeat these special provisions impacting upon partnerships here (see s 169I(8)) but, in essence, the provisions create a statutory fiction so that typical transactions involving a partnership can fit easily within the entrepreneurs' relief provisions.

In particular, s 169I(c) states that at any time when a business is being carried on by a partnership, the business (of the partnership) is to be treated as owned by each individual partner.

Thus, a partnership comprising ten partners with a £10 million turnover from making and selling widgets will be regarded for entrepreneurs' relief as ten separate businesses being carried on by each of the partners as a sole trader, i.e. by implication each partner having a business with a £10 million turnover (a total £100 million). This fiction is created to make the legislation work.

However, Mark singles out for special attention HMRC's comments in relation to the clause in s 169I(8)(b) — explained in the Capital Gains Manual as enabling a disposal by a partnership of the whole or part of the partnership business to be treated as though it were a disposal by the individual partner of that same partnership business disposed of (or that same part of the partnership interest disposed of).

The combination of the provision deeming the entire partnership business to be carried on (as if by magic) by each partner and the deeming of each disposal of a business (or each disposal of a part of a business) to be treated as a disposal by each of the partners, cleverly results in each partner being able to claim entrepreneurs' relief in respect of his or her actual assessable capital gain. (The aforementioned 'deeming' takes place only to facilitate entrepreneurs' relief and not for all purposes of the capital gains tax legislation.)

McGregor v Adcock

However, Mark seems to take exception to HMRC's statement that 'relief will not be available for disposals of partnership assets, unless the disposal constitutes the disposal of part of the partnership business' and suggests that this is in some way contradictory to the statute. In my view, the manual is both clear and correct in this regard.

The position is that the principle in McGregor v Adcock [1977] STC 206 applies to partnership situations in the same way as it does for sole traders.

Section 169(I)(8)(b) — the provision deeming the partnership's business to be treated as though it were owned by each partner, only applies to businesses or parts thereof.

Therefore, if a professional partnership owning an office building standing on three acres of ground sells half an acre of land (say, previously used for car parking) to a third-party, the deeming provision in s 169I(8) will not operate because there has been neither a disposal nor a part-disposal of the partnership's business.

In different circumstances, the court decisions relating to the now abolished retirement relief have suggested that a single asset sale can have such an impact on the business that it does fall to be treated as a disposal of part of a business.

HMRC's comment that 'relief will not be available for disposals of partnership assets, unless the disposal constitutes the disposal of part of the partnership business' merely emphasises that normally a simple asset sale will not attract relief. I am therefore quite comfortable about HMRC's comment.

Associated disposals

Associated disposals and the concept of 'withdrawal from participation' in s 169K is a tricky area. When practitioners are advising on a prospective transaction they must do so with great care. That said, I do not share the same concerns as Mark does about HMRC's Capital Gains Manual.

Quite rightly, the manual makes clear that it is not considered necessary for an individual to retire from the business or indeed to reduce his or her workload in order to make a material disposal.

Section 169K effectively addresses the situation where an asset (say, the asset made available for use in the business) is used in the business carried on, but is held outside of the trading vehicle. It applies where the asset made available for use in the business is either:

• used in the business of a partnership in which the asset provider is a partner; or
• used in the business of the individual provider's personal company (which is a trading company, etc).

Where an asset provided for use in the business, but held outside the business vehicle is disposed of at the point of (or in conjunction with) the disposal of all or part of the asset owner's interest in the business, the gain on the asset in question may be reduced by the available entrepreneurs' relief — if the asset disposal takes place as part of his withdrawal therefrom. (There are a number of restrictions which operate to reduce the amount of relief and these are set out in s 169P(4), but these are outside this short article.)

HMRC's examples

In the Capital Gains Manual at paragraph CG63995, two examples are given; one about G owning a farm shop used by a partnership of which he is a member and the other about R being the owner of a factory provided to R's personal company. 

Mark refers to these and to HMRC's own commentary thereon. HMRC's comment states, as per Mark's article:

'In these examples, the material disposal (G's reduction of his interest in the assets of the partnership [a 2/5ths reduction], and R's disposal [a disposal all her shares] together with the associated disposals [of the farm shop and factory respectively] would represent a withdrawal from participation in the business.'

However, Mark concludes from the two examples and HMRC's comment that their view is that it is necessary to materially reduce the interest in the partnership or in the company in order to achieve relief. This is not so and I do not believe that this should be construed from paragraph CG63995.

Mark rightly says that, in some cases, the statute provides for the associated disposal provisions to operate where as little as one share in the individual's assets provider's personal company is disposed of along with the asset.

The example in the manual is not intended to imply a minimum requirement and neither is the manual intended to be a tax planner's guide. There may well be cases where the associated disposal provisions operate where the individual owning an asset provided to a company disposes of, say, just 1% of his shareholding (albeit maybe only in a few such successful cases) and there will be cases where relief will be denied.

Each case will depend on its own facts — though I accept that the level of contrivance involved may well influence, rightly or wrongly, HMRC's approach.

The size of the disposal

While sharing Mark's view of the legislation, I remain comfortable with the examples given in paragraph CG63995 (as referred to above). All that needs to be said is that, when striving to take advantage of the relief available under s 169P in a tax planning situation, it would not be prudent to make the minimum disposal out of the taxpayer's equity interest in the business, i.e. a disposal of 10% of the equity previously held is better than a disposal of 5% thereof, a disposal of 15% of the equity interest held is better than a disposal of 10%, and so on.

In the final analysis, HMRC will have difficulty resisting a claim where the asset provided for use in a business is disposed of and the buyer thereof also acquires from the vendor just 1% of the equity of the business.

Contrast this with a situation where the 1% interest in the equity is simply transferred to the taxpayer's spouse at the same time as the asset provided for use in the business is disposed of to a third party. Here, resistance may well be anticipated.

It may be unsatisfactory that the adviser will not always be able to tell whether a disposal will be accepted by HMRC as taking place 'as part of [the taxpayer's] withdrawal from participation in the business' in question (s 169K), but the starting point will be to look at the motive for the asset sale and work from there.

Nothing in the legislation requires the taxpayer to reduce his involvement in the business 'materially' in my view and I do not see that the manual suggests this to be so either.

Delayed sales

Associated disposals and delayed sales can also be problematic. The legislation relating to unincorporated businesses specifically addresses the situation where a business asset in use at the date of cessation of a business is sold at a date subsequent to the cessation.

In short, the capital gain thereon may be reduced by entrepreneurs' relief if the period between the cessation date and the subsequent disposal is three years or less.

Likewise, the relief continues to be made available in respect of certain trading companies (or holding companies of a group where the group is within the definition of trading group) where the trading status is lost, but the shares are not disposed immediately.

Here again, the taxpayer has three years after the cessation of trade in which a share disposal can still be made and which can attract entrepreneurs' relief if all the conditions of s 169(7) are met.

However, the application of s 169K (associated disposals) is not so clear as regards assets owned outside the trading vehicle which are sold subsequent to the date of cessation of the business in which the asset was used.

Clearly, such an asset sold at or about the time of cessation of the business presents few problems, but what about an asset sold much later, say up to three years later? What happens if the disposal of the business interest was a disposal of part of the business only as in the Example?

In the Example, the answer is that, at first sight, there may well be a problem. A long delay may suggest to many inspectors that the asset disposal was not made as part of the withdrawal from the business.

However, as Mark explains, HMRC have decided to tell inspectors that they should normally allow an interval of up to three years. This construction of the legislation is certainly in keeping with the spirit of the provisions, but here I agree with Mark that the way the issue is being addressed is to allow a seeming deficiency in the legislation to be compensated for by a generous interpretation.

Conclusion

Mark's question remains, however. If the legislation can, as it does, specifically provide for entrepreneurs' relief to be extended to gains on the post cessation disposal of assets used by a sole trader, why can we not have greater certainty by amending the provisions relating to associated disposals so that there is no need to rely upon HMRC's Capital Gains Manual? It's not going to happen, though.

Kevin Slevin is the author and publisher of Entrepreneurs' Relief: A Guide for Accountants. He can be contacted on 0118 988 7055 or at kevin@slevinassociates.co.uk.

Issue: 4185 / Categories: Comment & Analysis