2020 innovation capital taxes update and planning

Capital Taxes - Update and Planning – September 2017

2020 Innovation

Capital Taxes Update and Planning

September 2017

Martyn Ingles FCA CTA

Ingles Tax and Training Ltd

No responsibility for loss occasioned to any person acting or refraining from action as a result of the material in this document can be accepted by the author or 2020 Innovation Training Limited.

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Capital Taxes – Update and Planning

1. PRINCIPAL PRIVATE RESIDENCE EXEMPTION ........................... 4

1.1 Basic Rules ................................................................................ 4 1.2 Periods of non-occupation ......................................................... 4 1.3 Letting Relief .............................................................................. 5 1.4 Election where there is more than one main residence .............. 5 1.5 Test of residence for PPR .......................................................... 5 1.6 Married couples and Principal private residences ...................... 7 1.7 Availability of relief to Trusts and Estates ................................... 7 1.8 Capital Gains on Non-Residents from 2015/16 .......................... 8

2. GIFT RELIEF .................................................................................... 9

2.1 Gift of business assets (Holdover)(s165 TCGA 1992) ................ 9 2.2 Restriction by non businesses assets ...................................... 10 2.3 Gifts on which there is an immediate IHT charge (s260 TCGA) 11 2.4 Self settlement anti-avoidance ................................................. 11

3. REPLACEMENT OF BUSINESS ASSETS (ROLLOVER) ............... 12

3.1 Introduction .............................................................................. 12 3.2 Used in Trade .......................................................................... 12 3.3 Qualifying Assets ..................................................................... 12 3.4 Groups of Companies .............................................................. 13 3.5 Reinvestment in Depreciating Assets ....................................... 13

4. CGT RELIEF ON INCORPORATION .............................................. 13

4.1 Entrepreneurs’ relief restricted on incorporation ..................... 14 4.2 Impact of new lower CGT rates from 2016/17 .......................... 14 4.3 Alternative strategies on incorporation ..................................... 15 4.4 Relief under Section 162, TCGA 1992 (incorporation relief) ..... 15 4.5 Relief under Section 165 TCGA 1992 (gift of business assets) 16 4.6 Transfer of property business to a limited company ................ 16

5. SECURING 10% TAX ON THE SALE OF THE BUSINESS ............ 17

5.1 Overview of Entrepreneurs’ relief ............................................. 17 5.2 Entrepreneurs’ Relief - Disposal of shares .............................. 18 5.3 Meaning of ‘trading company’ and ‘trading group’ ......................... 18 5.4 Business Premises owned outside the company ......................... 19 5.5 CGT Investors relief ................................................................. 22 5.6 Recent Cases Involving Entrepreneurs’ Relief ......................... 22

6. LIQUIDATIONS AND OTHER CAPITAL DISTRIBUTIONS ............. 25

6.1 Anti-Avoidance Announced in 2015 Autumn Statement ........... 25 6.2 New Legislation in Finance Act 2016 ....................................... 25 6.3 HMRC Manual – Company Winding Up TAAR ......................... 27

7. CAPITAL TAX PLANNING USING EIS AND “SEED” EIS .............. 32

7.1 Overview of Enterprise Investment Scheme (EIS).................... 32 7.2 Qualifying Trading Company .................................................... 32 7.3. Qualifying individuals for EIS ................................................... 34 7.4 Seed EIS (SEIS) ...................................................................... 36 7.5 Seed EIS before EIS – and use the correct form! ..................... 37


7.6 Paying 20% CGT Instead Of 28% On The Sale Of Property .... 38

8. IHT REFRESHER AND BASIC PLANNING .................................... 40

8.1 Inheritance Tax Overview ........................................................ 40 8.2 Take Advantage of Lifetime Exemptions .................................. 40 8.3 Inheritance Tax on gifts between spouses ............................... 40 8.4 Reduced IHT rate if leave 10% to charity ................................. 40 8.5 Gifts out of Income? ................................................................. 41 8.6 Potentially Exempt Transfers (PETs) ....................................... 42 8.7 Chargeable Lifetime Transfers ................................................. 42 8.8 Cumulation – Interaction of Lifetime and Death Rates ............. 42 8.9 Inheritance tax taper relief ........................................................ 42 8.10 Transfer of the IHT Nil Rate Band to Spouse ........................... 43 8.11 Additional Main Residence Nil Rate Band (RNRB) .................. 44 8.12 “Downsizing” to a Cheaper Property ........................................ 45 8.13 Business Property Relief .......................................................... 47 8.14 Danger Areas Regarding BPR and APR .................................. 49

DISCLAIMER AND COPYRIGHT

No responsibility for loss occasioned to any person's action or refraining from action as a result of reliance upon any information in the material can be accepted by the speaker. Tax legislation and case law are complicated and these course notes should not be regarded as offering a complete explanation of every topic covered.


1. PRINCIPAL PRIVATE RESIDENCE EXEMPTION

1.1 Basic Rules

An individual is exempt from capital gains tax on all or part of a gain on the disposal of his only or main residence. The exemption applies to the disposal of, or of an interest in:

a dwellinghouse or part of a dwellinghouse which is, or has at any time in his period of ownership been, his only or main residence, or

land which he has for his own occupation and enjoyment with that residence as its garden or grounds

In certain circumstances trustees may claim exemption for the only or main residence of a beneficiary under a settlement (see below). The exemption may also apply to separate buildings in the grounds of the dwelling house such as a bungalow built on the land as a residence for the caretaker of the house and his wife physically separate from the main house. On its ultimate sale it was held that the gain on the bungalow was tax free as in its ordinary usage, the word “dwelling house” or “residence” could comprise several buildings not physically joined together and a staff flat with its own access could accurately be described as part of the larger house. In Batey v Wakefield (1981) Fox LJ stated: “. . . what one is looking for is the entity which in fact constitutes the residence of the taxpayer”. The bungalow comprised part of that entity, thus the capital gains tax exemption applied on the sale of it. Exemption is also extended to a dwelling house owned by an individual who lives in job-related accommodation but intends to live in the house in the future.

1.2 Periods of non-occupation

Where the house has been the owner’s only or main residence throughout the whole period of ownership, the exemption will extend to the whole of any gain arising on disposal. For this purpose the benefit of the exemption extends in respect of any part of the last 18 months (36 months up to 5 April 2014) of ownership, even though the house had then ceased to be used as a residence by the owner. This provision is to allow a reasonable time for the old residence to be sold having acquired a new residence. In respect of disposals after 5 April 1988, any period of ownership before 31 March 1982 is ignored. Certain other periods of “absence” from the property may also be ignored in computing the period to which the exemption applies. In three cases periods of absence are disregarded and the house is still regarded as the individual’s only or main residence as long as he occupied it as such at some time both before and after the period. In these three cases “period of absence” means a period during which the house was not the individual’s only or main residence and throughout which he had no residence or main residence eligible for relief.

a) a single period of absence up to a maximum of three years, or shorter periods of absence which do not exceed a total of three years for any reason;

b) any period of absence, however long, provided that throughout the whole period of absence the individual worked in an employment or office, all the duties of which he performed abroad.

c) a period of absence up to a maximum of four years, whether at one time, or spread over different periods of absence totalling in all not more than four years, during which the individual was prevented from residing


in his house in consequence of the individual being required to work elsewhere in the UK.

1.3 Letting Relief

The exemption for gains on the disposal of an only or main residence is extended where the owner has let all or part of the dwelling house as residential accommodation. The chargeable gain is reduced by the lesser of:

an amount equal to the exemption of the gain in respect of occupation by the owner, and

the gain attributable to the let period, not otherwise exempted, and

£40,000 This additional exemption applies to gains arising from a residential letting of the entire residence, that is, to periods of non-occupation by the owner, as well as to lettings of part of the residence whilst the owner is still in occupation. There is no requirement for the owner to reoccupy it as a main residence following the period of letting.

1.4 Election where there is more than one main residence

Generally a taxpayer can only have one main residence in respect of which a claim for exemption can be made. Where a person has two or more residences, such as a house or flat in a town and another dwelling in the country or elsewhere, the question as to which is his main residence may not be easy to decide. The question of fact will still arise even where one residence is owned and another one is rented. For this purpose the owner may conclude the matter himself, by making an election stating which one is his main residence, and the period during which it has been his main residence. In the event that no such notice is given, the inspector may make a determination of which dwellinghouse is the main residence, either for the whole period of ownership or for specified parts of it. The notice must be served within two years of the beginning of the period to which the notice relates. The interpretation of this time limit has been considered in Griffin v Craig-Harvey, where the dispute centred on the period referred to in the phrase “beginning of that period”. It was held that the period referred to is the period of ownership of the two or more properties concerned, so that the two-year period begins to run from the time when it first becomes necessary for the inspector to decide, subject to election by the taxpayer, which of two or more residences is the taxpayer’s main residence. A notice once served may be subsequently varied by serving a further notice as the occasion arises (as for instance, when a new residence is acquired) but such a notice should be served within two years of the occurrence of the change; if it is served later, it only has effect in respect of a period beginning two years before its service.

1.5 Test of residence for PPR

There must be actual residence of the second property, what does that mean? The CGT Manual gives the following guidance to inspectors: The test of residence is one of quality rather than quantity of occupation. A dwelling house must have become its owners home. So no minimum qualifying


period of occupation can be relied upon to constitute residence. This point was expressed by Millett J in Moore v Thompson (61TC15) in the following terms. `It is clear that the Commissioners were alive to the fact that even occasional and short residence in a place can make that a residence; but the question was one of fact and degree for the Commissioners'. Every case must be decided on its own facts. Under the Representation of the People Act 1948 entitlement to vote in Parliamentary elections is given to persons resident in a constituency on a qualifying date. In Fox v Stirk, Ricketts v Registration Officer for the City of Cambridge [1970] 3 All ER 7 the Court of Appeal considered whether students should be regarded as resident in the constituency of the University they attended. Lord Denning M.R. commented that `I derive three principles. The first principle is that a man can have two residences. He can have a flat in London and a house in the country. He is resident in both. The second principle is that temporary presence at an address does not make a man resident there. A guest who comes for the weekend is not resident. A short stay visitor is not resident. The third principle is that temporary absence does not deprive a person of his residence. If he happens to be away for a holiday or away for the weekend or in hospital, he does not lose his residence on that account'. Lord Widgery commented that `This conception of residence is of the place where a man is based or where he continues to live, the place where he sleeps and shelters and has his home'.

1.5.1 CGT Private Residence Relief – Quality of Residence M Springthorpe v HMRC TC

832

A recent First Tier Tribunal case considered this concept of ‘quality of residence’. Mr Springthorpe (S) was divorced in 1997. He sold his former matrimonial home in November 1998 and began staying with his brother. In November 1999 he purchased a house which was in very poor condition. He began renovating it and in July 2000 he let it to students. He sold it in 2005. HMRC formed the opinion that the house had never been S's principal private residence and issued an amendment to S's self-assessment for 2005/06. S appealed, contending that the house had been his principal private residence between November 1999 and July 2000, when he began living with a widow. The First-Tier Tribunal dismissed S's appeal, finding that he had 'failed to discharge the burden of proof' that he had occupied the house as his residence. The Judge observed that the electricity bills had been minimal, there had been no cooking facilities, and 'the gas had been switched off until March 2000 with the result that there was no hot water available for washing'. To the extent that S had occupied the house, 'he did so for the purpose of renovating the property rather than occupying it as his home which he expected to occupy with some degree of

continuity'. HMRC also successfully challenged the availability of PPR in the case of Moore v HMRC FTT 2016 where the taxpayer purported to live in one of his buy to let properties following the separation from his wife. However evidence showed that he had actually moved in with his new wife to be and there insufficient quality and quantity of occupation for the property disposed of to have ever become his main residence, the Judge making reference to an earlier decision in Goodwin v Curtis.


1.6 Married couples and Principal private residences

Spouses (and now civil partners) are normally able to have only one residence between them which can qualify for relief from CGT on the disposal of a "principal private residence". Thus when a couple marry and each have their own residence they will either move into one of the two residences or purchase a new matrimonial home for their joint occupation. This means that the main residence exemption will no longer apply in respect of one or more of those properties. Note that where the property has been the main residence of the taxpayer in the past the last 3 years will continue to attract the exemption and consideration should be given to disposing of the property within the 3 year period for the gain to completely exempted. Another method of sheltering this gain would be to let the property to take advantage of letting relief of up to £40,000.

1.6.1 Main residences following separation

When a couple separate the family home will cease to be the main residence of the spouse who leaves it. His or her share on any calculated gain on subsequent sale will be chargeable to the extent that it relates to the period of non-residence. Again the last 36 month rule would be relevant here even if the departing spouse acquires a new residence. There is an important Inland Revenue Concession D6 covering absences of more than 3 years following separation or divorce, but this only applies where the property is eventually transferred to the spouse remaining in it as part of the financial settlement, and an election has not been made for a new qualifying main residence by the spouse moving out in the meantime. The private residence exemption can be preserved on divorce if a court order known as a Mesher order is made, under which the sale of the home is postponed, with a spouse and children remaining in occupation until a specified event, such as the children reaching a specified age or ceasing full-time education. This is treated as a trust, and occupation of the property by a trust beneficiary qualifies for the private residence exemption. Thus on the sale of the family home by the trustees the resulting gain would be covered by the private residence exemption.

1.7 Availability of relief to Trusts and Estates

Trustees can also claim principal private residence relief under the terms of s225 of TCGA 1992. The exemption applies to gains accruing to trustees on the disposal of a house if during the period of their ownership of it the house has been occupied as his or her only or main residence by a person “entitled” to occupy it under the terms of the settlement. Previous advice would always be that any new settlement drafted contains express wording allowing beneficiaries to occupy the property in this way. Where a beneficiary is in such occupation of settled property as his only or main residence, the notice of selection of the house to be the beneficiary’s main residence, must be a joint notice signed by the beneficiary and the trustees. For example, a taxpayer has had a main residence and intends to sell it shortly. He can let it for up to 3 years before sale without jeopardising his main residence relief by using the last 36 month rule. But if he could not find a buyer by the end of the 3 year period the classic advice would have been to transfer it to the trustees of a life interest settlement for himself to avoid losing the relief. That transfer would have triggerred a disposal which would not give rise to a chargeable gain by virtue of the last 36 month rule, the trustees would then take on the property at the then current market value and a buyer could be found


within the next few months. And hopefully there would be little, if any, additional gain which would be triggered by the trustees on the subsequent sale. Another planning point concerning trusts is where a property standing at a large potential gain is transferred to a settlement for the benefit of the children who would occupy the property as main residence under the terms of the settlement whilst studying at university for example. The classic advice would be for the couple to create a discretionary trust, then make a gift of the flat to the trustees on terms that allow a beneficiary to occupy it and of course their son would be one of the beneficiaries and they would be also included. Son then moves in, makes the flat his home while he’s in London. The parents would make a holdover election for capital gains tax purposes, so they’d pass the gain from having bought the flat to the date of the gift into the trust. The trustees would then sell the flat that has been the main residence of a beneficiary, so the special trust relief is due and that covers the gain the trustees themselves have made, plus the heldover gain from the parents, there was previously nothing to stop that and therefore the whole of the actual gain from the date when the flat was first bought would have been exempt because it’s been the main residence of the beneficiary. After that, assuming the trust has got the right powers, then the trustees could appoint the cash out to the parents or the children as required as a capital distribution. Unfortunately the type of planning outlined above which made use of the private residence relief available to trustees was blocked from 10 December 2003. The effect of the new provisions is that private residence relief will not be available in certain circumstances where the disposal in question is made on or after 10th December 2003 by an individual or the trustees of a settlement. These circumstances arise where the computation of the amount of any gain arising on the disposal has to take account of gifts relief obtained under section 260 of the TCGA in respect of an earlier disposal.

1.8 Capital Gains on Non-Residents from 2015/16

At Autumn Statement 2013 the Government announced that it will charge capital gains tax (CGT) on gains made by non-residents disposing of UK residential property, from April 2015. The charge came into effect in April 2015 and apply only to gains arising from that date. Unlike other countries that collect tax on gains relating to disposals of residential property located within their jurisdiction, the UK does not generally charge CGT on disposals by non-residents. This means that any gain made by a non-resident individual on UK residential property is either taxed in the individual’s country of residence, or not taxed at all. In contrast, UK resident individuals are subject to CGT on disposals of any residential property that is not their primary residence, including on the gains made on any residential property they own abroad. The taxation of gains made on residential property that is owned in other ways by UK persons – through trusts, companies and funds – is either subject to UK CGT, or UK corporation tax (CT), depending on the nature of the investment and the structure involved.

1.8.1 Non-UK Resident CGT Charge

Following consultation in summer 2014 the Government has legislated that from 6 April 2015 non-UK resident individuals, trusts, personal representatives and narrowly controlled (close) companies will be subject to Capital Gains Tax (CGT) on gains accruing on the disposal of UK residential property on or after that date. This has been legislated in section 37 and Schedule 7 to Finance Act 2015. Non-resident individuals will be subject to tax at the same rates as UK taxpayers (28% or 18% on gains above the annual exempt amount). Non-resident


companies will be subject to tax at the same rates as UK corporates (20%) and will have access to an indexation allowance. In order to calculate the amount chargeable the gain will be computed with reference to the market value at 6 April 2015. Alternatively it will also be possible to elect to compute the gain on a time-apportioned basis with only the post 6 April 2015 portion being chargeable.

Example 1 Frau Merkel lives in Germany but bought a holiday cottage in England in April 2005 for £500,000 which she uses for 2 weeks a year. She sells the cottage in April 2020 for £650,000. The market value of the cottage on 6 April 2015 was £550,000. The gain computed with reference to 6 April 2015 value was £100,000. The time apportioned gain based on cost was £150,000 x 5/15 = £50,000 An election to use the time apportionment basis is thus beneficial.

1.8.2 Private residence relief for non-residents – the 90 day test

In order to limit the availability of private residence relief on the disposal of residential property by non-residents, from 6 April 2015 an individual will only be able to claim private residence relief on a property situated in a territory in which they are not resident if they have spent at least 90 days in the property during the tax year concerned. Like the statutory residence test days are counted based on occupation at midnight, referred to by some as the “Cinderella” test. For married couples the 90 day occupation rule will be based on their combined period of occupation during the tax year concerned, although it will not be possible to count the same day twice. Full details are set out in section 39 and Schedule 9 to Finance Act 2015. Note that this change will affect UK residents who claim PPR against a foreign property, as well as non-residents disposing of UK residential property.

2. GIFT RELIEF

2.1 Gift of business assets (Holdover)(s165 TCGA 1992)

Up until 13 March 1989 there was a general relief for gifts of any asset. This was replaced by a requirement that the asset concerned was a “business asset”. The relief applies where the transferor (individual or trustee) makes a disposal other than at arms length to a transferee, and the two parties make a joint claim for the gain to be held over. Where the transferee are the trustees of a settlement only the settler is required to sign the claim. An asset is eligible for hold over relief if either

it is, or is an interest in, an asset used for the purposes of a trade, profession or vocation carried on by the transferor, his ‘personal company’ or a member of a ‘trading group’ of which the ‘holding company’ is his personal company), or

it consists of shares or securities of a ‘trading company’, or of the holding company of a trading group, where either the shares etc. are neither listed on a recognised stock exchange nor dealt in on the Unlisted Securities Market (now closed) or the trading company or holding company is the transferor’s personal company.

For these purposes, an individual’s ‘personal company’ is a company the voting rights in which are ‘exercisable’, as to not less than 5%, by that individual.


For 2003/04 onwards, ‘trading group’, ‘holding company’ and ‘trading company’ have the same meanings for these purposes as they do for the purposes of taper relief, now entrepreneurs’ relief. For 2002/03 and earlier years, they had the same meanings as for the purposes of retirement relief. Hold over relief is no longer available where the disposal is a transfer of shares or securities after 8 November 1999, and the transferee is a company. (For disposals between 6 April 2003 and 20 October 2003 this anti-avoidance measure was inadvertently repealed but reinstated by Finance Act 2004) Where the disposal is at an undervalue and some consideration is received by the transferor, the amount of consideration received that exceeds the original cost of the asset cannot be held over but is chargeable (less taper) on the transferor.

2.2 Restriction by non businesses assets

In the case where the shares gifted comprise the individual’s personal company, or the shareholding is 25% or more, the amount of gain that may be held over is restricted to the following proportion:

Market value chargeable business assets (CBA) Market value chargeable assets (CA)

Thus where the company has significant investments not being held for trading purposes it may not be possible to hold over the entire gain, which may result in capital gains tax being payable. Traditionally goodwill has been treated as one of the company’s chargeable business assets, however since the intangible fixed assets regime was introduced by Schedule 29 Finance Act 2002 “new” goodwill created or acquired on or after 1 April 2002 is no longer treated as a chargeable asset. This can have a significant impact on the MV CBA fraction. Example 2 Mr Bloggs, who owned 55% of the shares in Bloggs Trading Ltd, gave his son Joe a 10% shareholding reducing his shareholding to 45%. The market value of the company’s assets were as follows: £ Freehold factory and office 300,000 Fixed plant and machinery 50,000 Goodwill 1,250,000 Investment property 150,000 Other net assets (non chargeable) 250,000 Total market value of business 2,000,000 If the goodwill of the business is “old” pre 1 April 2002 goodwill the MV CBA restriction would be: MV Factory, offices, plant plus goodwill = £1,600,000 MV Factory, offices, plant ,goodwill and investments = £1,750,000 i.e. 91.4% However, if the goodwill of the business is “new” post 1 April 2002 goodwill the MV CBA restriction would be: MV Factory, offices plus plant = £350,000 MV Factory, offices, plant and investments = £500,000 i.e. 70%


If the 10% shareholding was worth say £40,000 and the shares had a base cost of £10 Mr Bloggs would have a gain of £39,990. If the goodwill is old goodwill the gain held over by s165 would be £36,551, leaving £3,439 chargeable. If the goodwill is “new” the gain chargeable would be £11,997. The resulting gain would be eligible for entrepreneurs relief but nevertheless a small amount of capital gains tax would be payable where the goodwill is “new” goodwill.

2.3 Gifts on which there is an immediate IHT charge (s260 TCGA)

This provision provides for the resulting gain on the transfer of any asset to be held over in circumstances where there is an immediate charge to inheritance tax. The most common example is where the transfer is to or out of a discretionary trust although Finance Act 2006 has extended this to most lifetime transfers of assets to trust, including A&M settlements and interest in possession trusts, previously treated as PETs. (The only exception now would be transfers to a trust for a disabled person). Note that the relief is still available where no inheritance liability results, for example where the value transferred falls within the nil rate band. Relief is available under s260 TCGA 1992 for disposals to the trustees or by trustees where the transfer is a chargeable transfer within the meaning of the Inheritance Tax Act 1984. This relief can be used where the asset transferred does not qualify for gift of business holdover under s165 TCGA, for example a plot of land, a second home, or a buy to let property. Example 3 Cliff owns an investment property which cost £60,000 in 1995 and is currently valued at £300,000. He wishes to transfer the property to his adult daughter Elizabeth but transferring the property would result in a £240,000 capital gain and a substantial CGT liability as he is a higher rate taxpayer. One alternative would be to transfer the property to a trust for the benefit of Elizabeth. Such a transfer would be chargeable to inheritance tax but as the value falls within the £325,000 nil band no IHT would be payable (assuming his nil rate band is unused). This would allow a s260 holdover claim to be made so that no CGT is payable by Cliff on the transfer. After a period of at least 3 months the property could be appointed to Elizabeth absolutely by the trustees. Again this transfer would be subject to IHT (exit charge) but again no IHT would be payable as the IHT charge would be based on the initial principal charge rate 0% as the initial value was below £325,000. Because the transfer is charged to IHT (albeit @ nil) it would be possible to claim s260 holdover a second time on the transfer to Elizabeth. Her base cost for subsequent disposal would be Cliff’s original £60,000 but the transfer will have been achieved without a CGT liability.

2.4 Self settlement anti-avoidance

As a result of changes in Finance Act 2004, announced in the 2003 pre-Budget Report and taking effect from 10 December 2003, no hold over is now available where the settlor has an interest in a trust to which an asset is transferred so a gain would crystallise upon the transfer to the trust. This has effectively blocked the use of a self-settlement to eliminate “tainted taper” where for example a shareholding did not qualify for business asset taper during the period 6 April 1998 to 5 April 2000. A further measure bites where the settlor, or spouse, acquires an interest in the trust at any time in the six years following the year in which the asset was settled. Where the original hold over was on or after 10 December 2003 there will now be


a clawback of any hold over relief claimed in the year in which the settlor acquires the interest. Note that Finance Act 2006 extended the definition of settlor interested trusts to include trusts for the benefit of minor (U18) unmarried children.

3. REPLACEMENT OF BUSINESS ASSETS (ROLLOVER)

3.1 Introduction

This relief can be claimed where a person carrying on a trade disposes of a qualifying asset that has been used in the trade (the old asset) and uses the proceeds to purchase another qualifying asset to be used in the trade (the new asset). The aim of the relief is:

To reduce the gain on disposal of the old asset to nil; and

The base cost of the new asset is reduced by the same sum. The trade must be a trade as specified in the statute which includes “every trade, manufacture, adventure, or concern in the nature of a trade”. A company who lets property or carries on an investment business is not trading and, therefore, is unable to claim rollover relief.

3.2 Used in Trade

In order to qualify for rollover relief, the new asset must be taken into use and used only for the purposes of the trade. Rollover relief is not available unless the asset is actually so used. The intention to use the new asset for the purpose of the trade is not sufficient. It is the use of the asset at acquisition which determines the availability for rollover relief. However, it has been confirmed by the Inland Revenue that if there is a commercial justification for the asset being unused immediately after its acquisition, rollover relief may be allowed.

Temperley v Visibell [1974] STC 64

Campbell Connolly & Co Ltd

v Barnett [1994] STC 50

3.3 Qualifying Assets

Qualifying assets include:

Any building or part of a building or a permanent or semi-permanent structure in the nature of a building, occupied (as well as used) only for the purposes of a trade;

Any land occupied (as well as used) only for the purposes of a trade;

Fixed plant and machinery which does not normally form part of a building, etc;

Ships, aircraft and hovercraft;

Satellites, space station and space craft (including launch vehicles); [1982] STC 498

Goodwill*;

EU entitlement to farm payments* *Note that with effect from 1 April 2002 capital gains rollover relief is not available for companies reinvesting into intangibles. Instead the new intangibles regime applies.


3.4 Groups of Companies

A claim for rollover relief can be made in respect of a disposal made by one member of the group and an acquisition by another member.

Section 175 TCGA 1992 Section 170(4) TCGA 1992

For this claim to be made, the group must be a 75% group, however the requirement for there to be a UK parent company was abolished with effect from 1 April 2000. Where the company which acquired the new assets leaves the group within six years of acquisition, the rollover gain is crystallised by reference to the market value of the asset at the time it was acquired, not when the company leaves the group. Roll-a-round relief within a group is no longer possible since 28 November 1994. Originally, a gain was rolled into an asset acquired from another group member which had been acquired under the no gain / no loss provisions of Section 171. This actually allowed the gain realised on a separate disposal outside the group to be rolled over into the “acquisition” without any consideration actually leaving the group.

3.5 Reinvestment in Depreciating Assets

As with hold over on the gift of business assets the taper relief period is computed by reference to the date of acquisition of the replacement asset where the gain on the old asset is held over. This is the case when a non-depreciating asset such as freehold land and buildings or goodwill is acquired. Where the new asset acquired is a depreciating asset the gain on the old asset, after taper, is deferred and becomes chargeable on the earlier of:

The replacement asset ceasing to be used in the trade;

The disposal of the replacement asset; and

10 years after the date of acquisition.

4. CGT RELIEF ON INCORPORATION

Incorporation is a disposal between connected parties and is treated as a sale at market value by the sole trade/partners to the company and is thus potentially chargeable to CGT. Two reliefs are available to hold over the resulting gain on the transfer of goodwill – s162 and s165 TCGA 1992. However, the availability of business asset taper, and more recently entrepreneurs’ relief, has meant that many taxpayers were not taking advantage of these reliefs but were prepared to pay 10% CGT to benefit from a large loan account with the transferee company by claiming entrepreneurs’ relief instead. The restriction of entrepreneurs’ relief on the transfer of goodwill in Finance Act 2015 has meant that we need to revisit the use of the two alternative forms of relief. The choice of which relief is adopted will largely dictate the way the company is incorporated. Each have their own effects on:

what is transferred

Stamp duty

VAT and the choice will depend on:

i) existing factors such as attitude of bank to charging securities ii) short/medium term factors - are assets likely to be sold iii) long term - how soon is the business to be sold.


The reliefs are mutually exclusive.

4.1 Entrepreneurs’ relief restricted on incorporation

As announced in the Autumn Statement on 3 December 2014 CGT Entrepreneurs’ relief will no longer be available on disposals of goodwill to a company related to the person(s) making the disposal. This restriction has now been enacted in section 42 Finance Act 2015. This measure together with the denial of corporation tax relief for amortisation of the goodwill makes incorporation a much less attractive option for businesses and removes a major incentive to incorporate. The change applies to disposals on or after 3 December 2014. Example 4 Mr Jones — Pre 3 December 2014 incorporation: Mr Jones set up his business in 2004. He made £100,000 profits each year and had his goodwill is valued at £1m. On 30 November 2014, he transferred that goodwill without seeking rollover relief for £1m to Jones Ltd, a company he owns. He paid £100,000 capital gains tax after entrepreneurs' relief on 31 January 2016. He can draw £1m tax free from Jones Ltd as the company makes profits in future years. If Jones Ltd continued to make £100,000 profits a year, but amortised the goodwill at 10%, the company would make nil taxable profits. That saves £20,000 corporation tax and could allow Mr Jones to draw the full £100,000. Over ten years the tax would be the £100,000 capital gains tax paid on £1m profits and there is £900,000 net cash in the hands of Mr Jones. Mr Jones — Post 3 December 2014 incorporation: Suppose Mr Jones carried out the same plan on 6 December 2014. The capital gains tax on 31 January 2016 will be £280,000 on the £1m gain without entrepreneurs' relief. Jones Ltd, not able to claim tax relief on amortising the purchased goodwill, will pay £20,000 corporation tax each year so Mr Jones can draw £80,000. After ten years, the aggregate tax will be £480,000 (£280,000 capital gains tax plus £200,000 corporation tax). Mr Jones now has £520,000 net cash after ten years (his £800,000 draw less the £280,000 CGT). The company still owes him £200,000, which would take 30 more months to repay so he eventually has £720,000 cash but the company has paid a further £50,000 corporation tax. Over the 12.5 years the total tax paid is £530,000. Also, he would not be able to fund most of his £280,000 capital gains tax by the cash releasable before 31 January 2016. Note however the cut in the rates of CGT to 10%/20% from 6 April 2016 makes the sale of goodwill to a limited company worth considering again?

4.2 Impact of new lower CGT rates from 2016/17

Note that the new lower 20% CGT rate for higher rate taxpayers introduced with effect from 6 April 2016 may make the “sale” of goodwill to


your own company attractive again where the sole trader/partner has a high level of profits. Let’s assume that the sale of goodwill occurs on 30 June 2017. Assuming Mr Jones is a higher rate taxpayer and ignoring the annual CGT allowance there would be £200,000 CGT payable on 31 January 2019. This gives a 19 month time lag between the transfer of the goodwill and the payment of CGT and Mr Jones will end up with £800,000 net of tax. The old arguments with HMRC Shares and Assets Valuation division over the valuation of goodwill on incorporation will resume. Note that there would still be no corporation tax deduction for the value of the goodwill acquired by the company and the disallowance will significantly increase the corporation tax liability and limit the company’s ability to pay dividends.

4.3 Alternative strategies on incorporation

It is still possible to use s162 TCGA 1992 rollover relief (or s165 gift relief) to avoid an immediate capital gain on incorporation. The consideration for a s162 based incorporation has to involve shares issued, so there cannot be a simple cash-free drawing as with an amount outstanding on the sale of the goodwill. Relief under s162 TCGA is automatic if the conditions for the relief are satisfied and an election under s162A is required to disapply the application. The relief requires all of the assets (with the exception of cash) to be transferred to the company with the consideration being wholly or partly in shares. For investment businesses, such as those with property rental portfolios, the position on incorporation generally remains unaltered by the autumn statement changes. They would previously have had a 28% capital gains tax charge on incorporation of the investment properties unless s 162 rollover relief was obtained and the usual absence of goodwill with such businesses normally renders the intangible assets rules irrelevant. It is not possible to prevent a tax charge on incorporation by selling for nil consideration (assuming s 165 did not operate). This is because s17 TCGA 1992 imposes a market value on the sale of chargeable assets where there is not a bargain at arm's length. Another strategy might be to allocate more of the value of the business to properties that are transferred as a part of an incorporation rather than to goodwill. Note also the restriction only applies to the transfer of goodwill and not other intangibles. Again there may be scope for attributing value to a brand name, manufacturing know how, or other intellectual property, with the balance of the value of the business being attributable to goodwill. The latter will require expert valuation support and the stamp duty land tax position would need to be considered because market value applies the deemed consideration for SDLT purposes on incorporation.

4.4 Relief under Section 162, TCGA 1992 (incorporation relief)

Any gain or disposal is rolled over against the value of the shares issued as consideration if:

i) all the assets of the business (except cash) are transferred; ii) business is transferred as a going concern;


iii) consideration is wholly or partly in shares. Points to consider:

all business assets need to be transferred without fail (i.e. cannot hold factory outside)

ensure non business assets transferred out prior to incorporation or tax becomes due

tax payable on any cash received

a share premium account will arise on difference between nominal value of shares issued and assets transferred

gain on assets rolled over reduces base cost of shares therefore subsequent sale of shares could be expensive for CGT purposes

extract max cash prior to incorporation and reinject to make loan account and help pay accelerated tax on profits on cessation

assets transferred received uplift in base value to current MV. Very important if medium term sale considered

possible (?) to avoid factory transfer by transferring ownership to spouse who leases factory at full MV to sole trade prior to incorporation

stamp duty land tax could be expensive if not properly managed

4.5 Relief under Section 165 TCGA 1992 (gift of business assets)

those trading assets required by business are gifted to the company and the gain held over

from company and issue shares for cash to owners of business

by agreement goodwill sold to company for nominal figure – or higher figure to create value taxed at 10%

by agreement any other assets sold for their base CGT cost

consideration for goodwill and assets left on loan account

election entered into to hold over gain under S165

debtors and cash kept by sole trader and used to settle creditors and tax etc. Balance injected in company as loan account

Advantages:

only those assets needed transferred

Stamp duty minimised/eliminated (as no stamp duty on gift element/gifts)

very flexible

possible to effectively draw out of company 1982 value only - see case study

Disadvantages:

assets have low base value in company (but is this a disadvantage as high base values get eroded away by taper relief - see below).

shares have low base value (but is this a disadvantage as high base values get eroded away by taper relief - see below).

4.6 Transfer of property business to a limited company Mrs EM Ramsey v

HMRC(2014) UKUTT Classic advice has always been that property that is likely to be sold in the short to medium term should not be held in a limited company. This is because of the “double charge” that is likely to result, firstly the corporation tax charge on the sale of the property, and then the second personal tax charge on the extraction of the profit from the company by way of dividend or capital gain on liquidation of the company. These charges would not however arise if the properties are to be held long term in a family investment company although inheritance tax would need to planned for by the gradual lifetime transfer of shares to subsequent generations. The structure has the added advantage of not being subject to the IHT 10 year


anniversary charges that now apply to most trusts set up during the settlor’s lifetime, The abolition of indexation allowance and taper relief for individuals coupled with the reduction in corporation tax rates (potentially to 17%) has meant that ownership of rental properties in a company, particularly where these are to be retained long term may be worth considering. Note also that indexation allowance continues to be available in computing corporate gains so that the capital gain on disposal may no longer be such an issue. The ability to extract post tax profits from the company when required means that profits can be rolled up and paid out when required or in a year when the individual’s personal tax rate is lower (when the 45% rate is removed). The new restricted deduction for finance costs (20% only) that started from 6 April 2017 for individuals and partnerships does not apply to limited companies. This has caused many owners of property businesses to consider the transfer of the business to a limited company. This however has CGT and SDLT implications. Note that where the property rental business is currently in personal ownership either in sole name or joint names it is normally possible to take advantage of s162 TCGA 1992 hold over on the transfer of the business to a limited company as that relief refers to the transfer of a business not a trade. There may however be significant SDLT costs of such a transfer. A number of tax reliefs only apply to trading businesses, whereas other relieving provisions apply to businesses generally, including property businesses. One such provision is relief under TCGA 1992 s162. The decision in the following case before the Upper Tier Tribunal is worth careful consideration: Mrs Ramsay owned a large house in Belfast, which was divided into ten flats and let to tenants. In 2004 when the property was owned jointly by herself and her husband, they incorporated their lettings business. This involved transferring the property to a company in return for shares in that company and the couple took advantage of s162 relief to hold over the gains. Following an enquiry, HMRC issued a ruling that no s162 CGT relief was due, on the grounds that the property was an investment and was not a business. The Ramseys were represented at the appeal hearing by their son, who explained the Ramseys spent about 20 hours a week on tasks related to the property, such as maintenance, collecting rents, and cleaning the flats after tenants left. As such he argued the actions carried out by Mr and Mrs Ramsey constituted more than passive receipt of rents, and constituted a business. Judge Huddleston did not agree and the First-tier Tribunal dismissed the Ramseys appeal. The judgement appears to have confused what constitutes a 'business' needed for this CGT relief and the necessary conditions for a trade. Fortunately for many practitioners that have advised on similar transactions the Upper Tribunal allowed the taxpayers appeal. However it would be advisable to ensure that the individuals are actively involved in the rental business and do not merely delegate the day to day operations to a managing agent.

5. SECURING 10% TAX ON THE SALE OF THE BUSINESS

5.1 Overview of Entrepreneurs’ relief

Entrepreneurs’ relief, which replaced business asset taper originally worked by allowing the first £1 million of gains made on qualifying business disposals in a taxpayer’s lifetime to be charged to CGT at an effective rate of 10%.


The lifetime limit on gains qualifying for entrepreneurs’ relief was increased from £2 million to £5 million for disposals on or after 23 June 2010 and then to £10 million for disposals from 6 April 2011 onwards Three types of disposal qualify:

a material disposal of business assets

a disposal of trust business assets, and

a disposal associated with a relevant material disposal. A disposal of a business asset can be one of three disposals —

a disposal of the whole or part of a business (this is more than a disposal of assets used in a business; it requires the disposal of all or part of a business as a going concern);

a disposal of assets which were used for the purposes of a business that has now ceased, provided they were in use for those purposes at the time of cessation, or of interests in such assets; or

a disposal of shares in or securities of a company, or of an interest in such shares or securities.

The disposal of the whole or part of a business is a material disposal if the business is owned by the individual making the disposal throughout the year leading up to the date of the disposal. A disposal of the sort described in the second bullet above is a material disposal if the business is owned by the individual making the disposal for the period of one year immediately preceding the cessation of the business and the disposal takes place within three years of that cessation.

5.2 Entrepreneurs’ Relief - Disposal of shares

For a disposal of shares (or securities) by an individual, that disposal is ‘material’ if throughout the year prior to disposal:

the company is the individual’s personal company – in other words, the seller owns at least 5% of the ordinary shares giving him at least 5% of the voting rights, and

the company is a trading company or the holding company of a trading group – defined in the same terms as for taper relief, and

the individual is an officer or employee of the company or one or more of the companies that are members of the group.

Note in particular that there is no full time working requirement in the new legislation, unlike retirement relief and the early years of business taper. The disposal will also be material where the company has, within the three years immediately preceding the disposal, ceased to be either a trading company or a member of a trading group but satisfied the trading company test throughout the year preceding cessation.

5.3 Meaning of ‘trading company’ and ‘trading group’

“Trading company” or trading group status are crucial for the purposes of entrepreneurs’ relief, the substantial shareholdings exemption and gift relief. The legislation defines a “trading company” as a company carrying on “trading activities” whose activities do not to any substantial extent include activities that are not trading activities. This is common to both the substantial shareholdings exemption, the old CGT business asset taper and CGT entrepreneurs relief.


“Trading activities” include, for this purpose, activities carried on by the company preparatory to carrying on a trade or with a view to its acquiring a trade or starting to trade. They also include the acquisition of an interest in a company that becomes a trading subsidiary (or the holding company of a trading group. The acquisition of the trade or starting to trade must be made as soon as is reasonably practicable in the circumstances. “Trading group” is defined as a group one or more of whose members are carrying on trading activities and whose activities taken together (disregarding intra-group activities) do not to any substantial extent include activities that are not trading activities.An article in issue 53 of Tax Bulletin (June 2001) contained the Revenue’s interpretation (RI 120) of a number of important terms.

“Substantial” The word substantial is used in various sections of the legislation to provide some flexibility in interpreting a section without opening the door to widespread abuse of a relieving provision. The Revenue now state that substantial here means ‘more than 20%’. It is therefore necessary to consider what should form the basis for measuring whether a company’s non-trading purposes are capable of having a substantial effect.

“Substantial” means more than 20% The Revenue consider that this will vary according to the facts in each case but some or all of the following might be taken into account in reviewing a particular company’s status:

Turnover receivable from non-trading activities

The asset base of the company

Expenses incurred by, or time spent by, officers and employees of the company in undertaking its activities

Further guidance is given in the Revenue Interpretation on each of the three factors. It may be that some measures point in one direction and others in the opposite direction. The Revenue would therefore consider the issue “in the round” and would weigh up the impact of each of the measures to balance the effects of measures that point in different directions in coming to a view. If, at the end of the day, the inspector was unable to agree the status of a particular company for a period then this matter could only be ultimately established as a question of fact before the Commissioners. However, the Revenue anticipate that these cases will be relatively rare.

5.4 Business Premises owned outside the company

Until recently it was fairly standard advice from accountants that on the incorporation of sole trader or partnership it was advantageous to retain the business premises personally and rent the property to the newly formed company:

This avoided the potential “double charge” on the sale of the property – corporation tax on the gain followed by a second tax charge on extraction of value from the company

It also avoided SDLT on the transfer

Should the business fail the premises would not be available to the creditors, although lenders would often secure loans on the property.

The rental payments would be deductible for the company and yet not be subject to NI contributions


On subsequent disposal of the property, business asset taper meant that only 10% capital gains tax would be payable provided the property was used by an unquoted trading company. (In the early days it had to be the owner’s personal company.) Thus in the taper relief days the property did not need to be disposed of at the same time as the business and furthermore the charging of rent did not affect the availability of business taper. This has however all changed and business owners need to consider carefully their long term strategy.

5.4.1 The “Associated Disposal Rule” Changes in Finance Act 2008 will have a significant impact on the way that business property used in the owners company or partnership will be taxed in future. The new entrepreneurs’ relief provides that such a property will only be eligible for the effective 10% tax charge where the gain on its disposal would qualify as an associated disposal. The amount of such a gain is restricted if the premises are not used wholly for business purposes or where rent is charged to the business for its usage. The following guidance is provided in HMRC Capital Gains Manual:

Where certain “associated disposals” are made under TCGA92 s169K the amount of the gain qualifying for Entrepreneurs’ Relief may be subject to restrictions where any of a number of conditions are met. The conditions that can result in restriction are:

where the asset(s) which are the subject of the associated disposal were used for the purposes of the business during only part of the period for which they were owned by the individual making the disposal.

The adjustment will reflect the length of the period of business use.

where only a part of the asset(s) which are the subject of the associated disposal was in use for the purposes of the business for the period they were owned by the individual making the disposal.

The adjustment will reflect the part of the assets that was used for business purposes.

where the individual making the associated disposal was involved in the carrying on of the business (whether this was personally, as a partner, or as an employee or officer of the individual’s personal company) for only part of the period for which the assets which are the subject of the associated disposal were in use for the purposes of the business.

The adjustment will reflect the length of the period for which the individual was involved in the carrying on of the business.

where the whole or part of the period falling after 5th April 2008 (see FA2008 Sch 3 Para 6) for which the asset(s) which are the subject of the associated disposal were used for business purposes, they were available for that use only on payment of rent (and so were to an extent investments, rather than being employed solely for the purposes of the business).

The adjustment will reflect the extent to which the rent paid for periods after 5th April 208 is less than the full market rent for the assets.


“Rent” in relation to an asset, for the purposes of Entrepreneurs’ Relief, is defined at TCGA92 s169S(5) and includes any form of consideration given for use of the asset.

HMRC have provided the following guidance at CG63995 onwards:

What is considered a ‘just and reasonable’ adjustment in the context of TCGA92 s169P (5) will depend on the facts of the particular case. It is possible that two or more of the above conditions may be in point. A reasonably broad approach should be adopted aiming at arriving at a proportion that is equitable in the circumstances. You should not seek an adjustment where the conditions in TCGA92 s169P(4) are met only occasionally or to a trivial extent. In particular, no adjustment is required for periods when an asset is not in active use for the business if this is simply a reflection of the seasonal nature of a particular activity.

5.4.2 “Associated Disposal” Rule tightened up in Finance Act 2015

Section 41 FA 2015 has enacted the announcement on Budget Day that from 18 March 2015 CGT entrepreneurs’ relief will be restricted on certain “associated disposals”. The 10% CGT rate will no longer be available on the disposal of personal assets used in a business carried on by a company or a partnership unless they are disposed of in connection with a disposal of at least a 5% shareholding in the company or a 5% share in the partnership assets. Example 5 (based on previous HMRC guidance) Mr and Mrs Bloggs own 100 per cent of the shares in Bloggs Trading Ltd. It carries on a manufacturing and retail trade. But the premises from which the company trades are owned personally by them, not by the company. They decide to retire and in 2015 they close the business but sell their shares in the company to a competitor who wants to acquire the intellectual property. Having stood empty for a while it is not until later in 2015 that they sell the premises to a local developer to convert into apartments. Gains arise upon both transactions. As long as all the necessary conditions for Entrepreneurs’ Relief are met by both Mr and Mrs Bloggs in respect of the disposal of their shares their gains on the disposal of the premises will also attract relief as that disposal is an “associated disposal”. If Mr Bloggs qualified for Entrepreneurs’ Relief in respect of his disposal of shares, but Mrs Bloggs did not, only Mr Bloggs’s gain on disposal of the premises would qualify as an “associated disposal”. Thus, provided they each disposed of at least a 5% shareholding in the company they would both qualify for entrepreneurs’ relief in respect of the disposal of the premises.

It should be noted however that if the premises was used for some other purpose following disposal of the shares, for instance converted into apartments by Mr and Mrs Bloggs (as opposed to being sold to a developer) then when it is sold HMRC view is that it is unlikely to be an “associated disposal”. This is because the later disposal of the property did not arise as part of their withdrawal from the business. In any case that does not fall within the guidance at CG63995 it is important to ascertain the relevant facts to determine the reason for the delay between the relevant material disposal and the disposal of the asset in question.


5.5 CGT Investors relief FA 2016 s87 and Sch 14 Entrepreneurs’ Relief (ER), which gives a 10% tax rate for qualifying disposals, is to be extended to long-term investors in unquoted trading companies. Unlike ER the investor does not have to be an employee or officer of the company, or hold at least 5% of the share capital. In the original announcement employees and directors were specifically excluded but the legislation was amended to permit directors to benefit from investors relief. Provided the investor subscribes for the shares after 16 March 2016, and holds them for at least three years from 6 April 2016, the gain on sale will be taxed at 10%. There will be a lifetime cap on these investor gains of £10 million, which will apply separately to the £10 million lifetime cap for ER gains.

5.6 Recent Cases Involving Entrepreneurs’ Relief

5.6.1 CGT Entrepreneurs’Relief – the 5% Test

Castledine v HMRC [2016] UKFTT 145

Mr Castledine (Mr C) was the commercial director of a limited company (“P”) which was acquired by another company (“D”) in March 2007. In September 2007 Mr C retired leaving loan notes in D under an existing financial structure but returned a year later to assist in rescuing D from bankruptcy. The rescue was successful but included a restructuring of its finances in which C was allocated 5% of the ordinary shares. C subsequently disposed of loan notes in D worth £600,303 and £505,009 respectively and applied for entrepreneurs' relief in respect of that disposal.

HMRC disallowed the claim and Mr C appealed to the First-tier Tribunal. The issue for consideration was whether the company’s deferred shares counted as “ordinary share capital”. If the deferred shares were counted as “ordinary shares” Mr C held 4∙99% of the share capital of D; if they were excluded, C held exactly 5% of the company's share capital. In the former case, C would not have qualified for the relief on a strict reading of the legislation; in the latter case, he would qualify, even on a strict reading.

In determining whether deferred shares, counted as “ordinary share capital”, within the meaning of s989 ITA 2007, as applied to entrepreneurs' relief, it appeared that Parliament was making it clear that there were to be no fine distinctions or special exceptions in the matter; that a simple, broad brush, easily workable, approach was mandated. On the facts the creation of the class of deferred shares was openly commercial, and perfectly genuine. It had all the appearance of being a carefully devised means of ensuring the wellbeing of the company in the case of share-incentivised employees ceasing to play a part in it. The authorities, however, did require that whatever provisions Parliament had enacted had to be interpreted according to certain criteria. The first of those was that no difference was to be made between the construction of fiscal statutes and statutes dealing with other areas of the law. There had been no specific evidence before the tribunal to support the suggestion that Parliament intended more than the legislation stated, and to place weight on those speculations meant introducing to the statutory definition a layer of meaning which was not apparent at first reading; it also risked producing an unwelcome degree of uncertainty, with the all administrative problems which could follow.

The concern expressed by the Courts about an unduly literal interpretative approach to tax statutes, and the need to give a statutory provision a purposive interpretation in order to determine the nature of the transaction to which it was intended to apply, did not point towards an open-ended speculation as to where


Parliament intended to draw the line with regard to the meaning of “ordinary share capital”. The plain meaning of the legislation at issue could not be departed from.

The appeal was dismissed and Mr C did not hold the necessary voting control to qualify for CGT entrepreneurs’ relief.

Note however that in McQuillan [2016] TC 05074, the First-tier Tribunal found that shares with no dividend rights, had a right to a dividend at a fixed rate of 0% and were therefore excluded from the definition of ordinary share capital in ITA 2007, s. 989.

Mr and Mrs McQuillan each held 33 voting shares in a trading company(33%). Another couple held 17 voting shares each and 15,000 redeemable non-voting shares each representing a “loan” to the company. The shareholders agreement provided that “Any Redeemable Share Capital from time to time in issue shall not bear any voting rights and will be redeemable at par at a future date decided by the Directors at their sole discretion”. The shareholder agreement also provided that any dividends would be paid to the shareholders, but was silent on the question of the proportion in which they would be paid.

Had the 30,000 redeemable shares been regarded as ordinary shares the 33 shares owned by Mr and Mrs McQuinlan would have been swamped, giving them 33/30,100 less than 1% of the company’s ordinary share capital. The court held the redeemable shares were not ordinary shares for the purposes of determining whether the 5% test is satisfied.

Unfortunately, the McQuillan decision was recently appealed by HMRC to the Upper Tribunal and the Judge reversed the decision of the lower court aligning the decision with that in the Castledine case. The Upper Tribunal held that all shares need to be considered with the exception of those that carry a fixed dividend rate (preference shares).

5.6.2 No CGT Entrepreneurs’ relief as no longer an employee J K Moore v HMRC [2016]

UKFTT

One of the conditions for claiming CGT entrepreneurs’ relief is that the shareholder must be an officer or employee of the company for the 12 months prior to the disposal of his or her shares. The First Tier Tribunal have recently upheld the HMRC decision to refuse the claim made by Mr John Kenneth Moore on his self-assessment tax return in respect of a capital gain on a disposal of shares in Alpha Micro Components Limited (Alpha) as the result of a company buy-back of shares in 1999. As with many transactions the timing is critical to obtain the desired tax result.

Alpha was established in 1995 and is in business distributing electronic components. Mr Moore was one of the founding shareholders and directors. Prior to 2009, he held 3000 of the 10,000 issued £1 shares, held the office of Sales and Marketing Director and was employed under a contract of employment.

During the course of 2008, the direction of Alpha became the matter of a dispute between Mr Moore and the other shareholder directors and it was agreed that Mr Moore would leave the business. On 29 January 2009, one of the Alpha directors instructed solicitors to draft the necessary contractual documentation for settlement based on terms agreed through the mediation/negotiation process conducted by the company’s


accountants. The terms were agreed such that Alpha would purchase 2700 (90%) of Mr Moore’s 3000 shares; the remaining 300 shares would be converted to non-voting shares and clearance would be sought from HMRC that Alpha's acquisition of the shares would be treated as a capital transaction.

It was also agreed, but not recorded in the heads of terms, that Mr Moore’s employment would be terminated, that he would receive an ex gratia payment and that he would resign as a director.

On 29 May 2009, there was a general meeting of the company. At that meeting, which Mr Moore attended, it was resolved by special resolution that Alpha would purchase the 2700 shares. It was further resolved to take additional borrowing.

On the same day, Mr Moore signed a Compromise Agreement for the termination of his employment and the Agreement for Purchase of Own Shares. All Companies House papers concerning Mr Moore’s resignation as a director were also signed on that day. However, the documents state the effective date of his resignation as a director was 28 February 2009.

HMRC opened an enquiry into the return and concluded that Mr Moore was not entitled to claim Entrepreneurs' Relief because the statutory conditions set out in s 169 I (6)(b)TCGA had not been met. Specifically, he was not, throughout the period of one year ending with the disposal of his shareholding, either an officer or employee of Alpha. Mr Moore was assessed to an additional £37,348 capital gains tax.

The First Tier Tribunal have dismissed Mr Moore’s appeal against the additional assessment on the grounds that he did not satisfy the 12 month test as an officer or employee of the company. Under s28 TCGA 1992 the date of disposal of the shares is considered to be when the unconditional contract for disposal is made. For a company buy back of its own shares that would be the date of the passing of the special resolution, in this case 29 May 2009. As Mr Moore resigned as a director on 28 February 2009 the 12 month condition as an officer or employee of the company was not satisfied and CGT entrepreneurs’ relief was not available.


6. LIQUIDATIONS AND OTHER CAPITAL DISTRIBUTIONS

6.1 Anti-Avoidance Announced in 2015 Autumn Statement

It was announced in the Autumn Statement on 30 November 2015 that from April 2016, the way in which dividends (and other company distributions) are taxed will be fundamentally reformed for individual recipients. The changes will increase the incentive to arrange for returns from a company to be taxed as capital rather as than income, attracting tax at lower Capital Gains Tax rates, rather than the new dividend tax rates. The government believes that it is unfair that some people can, in some cases, arrange their affairs solely to take advantage of lower tax rates. Consequently on 9 December 2015 HMRC issued a consultation and draft legislation designed to prevent tax advantages being obtained from specific types of behaviour. The proposed legislation would:

amend the Transactions in Securities legislation, which is designed to prevent unfair tax advantages in certain circumstances. The amendments would strengthen these rules, and clarify certain areas; and

introduce a new Targeted Anti-Avoidance Rule, which would prevent some distributions in a winding-up being taxed as capital, where certain conditions are met and there is an intention to gain a tax advantage.

6.2 New Legislation in Finance Act 2016 Sections 33 to 35

Following the December 2015 consultation legislation has been introduced in Finance Act 2016 to amend the Transactions in Securities rules and introduce a Targeted Anti-Avoidance Rule in order to prevent opportunities for income to be converted to capital in order to gain a tax advantage. The new measures in sections 33 and 34 introduce amendments to the Transactions in Securities rules In Part 13 of Income Tax Act 2007 (ITA 2007). The changes clarify and tighten up a number of aspects of these rules. The amendments have effect for transactions occurring on or after 6 April 2016. There have been significant changes to the treatment of distributions to shareholders during the course of a winding up. New section 396B(1) explains that a distribution in respect of shares in the winding up of a UK-resident company is an (income) distribution if conditions A to D are met: Condition A: the individual receiving the distribution must have held at least a 5% interest in the company immediately before the winding up. Condition B: the company has to be a close company, or to have been a close company at some point in the two years before the winding up began. Condition C: that the person who receives the distribution is, at any time in the two years following the receipt, involved with the carrying on of a trade or activity that is similar to that of the trade or activity carried on by


the company wound up (or its subsidiary). For this purpose the individual may carry on the trade directly, through a partnership, through a company in which he or she has at least a 5% interest, or through a person with whom he or she is connected. Condition D: that it is reasonable to assume that the winding up forms part of arrangements designed to reduce the person's income tax liability. The legislation makes clear that condition D will address in particular the question whether the person continues in some way the same or a similar trade or activity. New section 396B(7) provides an exemption from the TAAR where the distribution received by the individual does not exceed the Capital Gains Tax "base cost", or where it comprises only irredeemable shares, as would be the case in a "liquidation de-merger". From 6 April 2016 s 684(1) ITA 2007 it will consider ʺthe purpose of the transactionsʺ in place of ʺthe purpose of a person being party to a transactionʺ. Section 684(1) will also apply to a tax advantage obtained by any person, not just the person who is a party to the transaction. There continues to be a let out if there is a fundamental change of ownership, provided that the original shareholder or original shareholders taken together with any associate or associates –

a) do not directly or indirectly hold more than 25% of the ordinary share capital of the close company,

b) do not directly or indirectly hold shares in the close company carrying an entitlement to more than 25% of the distributions which may be made by the close company, and

c) do not directly or indirectly hold shares in the close company carrying more than 25% of the total voting rights in the close company.

The new legislation also clarifies that a repayment of share capital or share premium is a transaction in securities by adding it to the particular examples listed in the section. It also extends the definition of transaction in securities to include a distribution in respect of securities in a winding up. Section 687 of ITA 2007 is amended so that an income tax advantage can be obtained where a distribution could have been paid to an associate of the person. It also clarifies when to consider the value of a distribution that could have been paid. Section 34 clarifies that HMRC will no longer be required to issue counteraction notices under the Transactions in Securities legislation and the new procedure will be aligned more closely with the process for

compliance checks under self‐assessment. The new procedure will have

effect for transactions occurring on or after 6 April 2016.

The new measures in section 35 introduce a new Targeted

Anti‐Avoidance Rule (TAAR) that will apply to certain company distributions in respect of share capital in a winding up. This TAAR will treat the distribution from a winding‐up as if it were a distribution


chargeable to Income Tax, where certain conditions are met. The TAAR applies to distributions made on or after 6 April 2016.

6.3 HMRC Manual – Company Winding Up TAAR

HMRC have finally included guidance in their Company Taxation Manual CTM (CTM 36300) on the operation of the Targeted Anti-Avoidance Rule (TAAR) dealing with the winding up of a company that applies to transactions on or after 6 April 2016.

The HMRC manual includes a number of examples and also confirms that they will not give statutory clearance prior to the transaction proceeding.

The purpose of new ITTOIA 200 section S396B introduced by s35 FA 2016 is to prevent individuals converting what would otherwise be a dividend into a capital payment, and so reducing their overall tax liability.

6.3.1 Targeted anti-avoidance rule (TAAR)

A distribution in a winding up made to an individual on or after 6 April 2016 will be treated as if it were a distribution where certain conditions are met. For the rule to apply, all of the following conditions must be met:

Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up

Condition B: the company was a close company at any point in the two years ending with the start of the winding up

Condition C: the individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound up company at any time within two years from the date of the distribution

Condition D: it is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to Income Tax.

A distribution in a winding up is not treated as a distribution under S396B to the extent that the amount of the distribution does not exceed the amount that would result in no gain accruing for the purposes of Capital Gains Tax, or where the distribution is of irredeemable shares.

Conditions A and B are fairly clear cut. Guidance on Conditions C and D are where more be required and HMRC guidance is set out below:

Condition C is met where the individual receiving the distribution in the winding up continues to be directly or indirectly involved with the same or similar trade or activity as the company being wound up at any time within two years from the date of the distribution.

The condition is widely drafted to prevent the rule being easily avoided by subtly changing the type of trade or activity of the company, or by changing the structure in which that trade or activity is carried out (for example by transferring the company’s trade to a partnership).


Condition C is met not only where a new company is created after the winding up of the company in question – it will apply wherever the individual receiving the distribution continues to carry on, directly or indirectly, the same or a similar activity.

Meeting Condition C does not, on its own, mean that the legislation will apply. All four of the conditions must apply, and while Condition C is deliberately wide, Condition D (the purpose test) will narrow the application of the legislation.

6.3.2 ‘Similar trade or activity’

The four subsections of ITTOIA 2005 section 396B (4) apply where the individual continues to be directly or indirectly involved with a trade or activity which is the same as, or is similar to, that of the company being wound up.

ITTOIA 2005 Section 396B applies not only to distributions from companies carrying on a trade but also to companies carrying on an investment business and to a holding company of a trading group, for example.

‘Similar trade or activity’ is not further defined and is a deliberately wide-ranging term designed to prevent arguments that a new company is not carrying on “the same” trade as the wound-up company because of changes to the business model.

Example 1 Mr G is the sole shareholder in a company that provides a car-washing service. Mr G winds up that company, but continues to provide car-washing services through a partnership with his wife, but now also sells air-fresheners.

Clearly Mr G is carrying on the same trade, or at least a trade very similar to that carried out by the company, and so Condition C is satisfied.

Example 2 Mrs F is a landscape garden designer and runs her business through a company. Mrs F decides she would like to retire, and so winds up the company. In order to supplement her pension, and because she enjoys it, Mrs F continues to provide routine gardening services to a small group of clients in her local village as a sole-trader.

It is unlikely that Mrs F is carrying on “the same trade” after the winding up as that carried on by the company. However, the provision of gardening services is “similar to” the provision of landscape gardening, and so Condition C is met. (But that does not mean that S396B will apply to the distribution, because all the conditions must be met, and it is not likely on these facts that Condition D – the purpose test – will be satisfied.)

Example 3 Mr E is a builder who runs his business through two companies – Company 1 specialises in loft conversions, and Company 2 specialises in


extensions. Mr E winds up Company 1, but the trade of Company 2 continues.

As with Example 2, Mr E continues to be involved with a trade that is similar to that of the company that is wound up, and so Condition C is satisfied.

Example 4 Mrs D is a recruitment consultant who runs her business through a company. After three years of training part time, she winds up her company and starts a new company that offers her services as an IT consultant. Some of her new clients are businesses she dealt with in her previous company.

Although Mrs D is still a consultant, the trade has changed significantly and it is unlikely that it would be viewed as the same or similar to that carried on by the wound up company. It does not matter that she continues to deal with some of the same clients because the nature of the service she is providing is different. Even if it were argued that the work was similar consultancy support, it is unlikely that Condition D would be met in any event.

Condition C is met where “the individual [who receives the distribution in a winding up] is involved with the carrying on of such a trade or activity by a person connected with the individual”.

6.3.3 “Involved with”

Like “similar trade or activity”, “involved with” is not a defined term and is potentially wide in scope. It is designed to prevent the TAAR being avoided by connected parties working together to circumvent the other conditions.

Example 1 Mrs C is an accountant who runs her business through a company. Her husband is a self-employed lion tamer. Mrs C winds up her company and starts work for a newly-formed company owned by her husband, providing accountancy services.

Mrs C continues to be involved with the same trade or activity as the wound-up company was involved with (the provision of accountancy services), even though she is now an employee rather than business owner. She is connected to her husband and so Condition C is met (and so are Conditions A and B). Condition D will still need to be satisfied.

Example 2 Instead of going to work for a newly-formed company, Mrs C, from Example 1, goes to work for her sister’s pre-existing accountancy practice, which the sister operates as a sole trader.

Mrs C is connected with her sister, and she is continuing to be “involved with” the same or a similar activity, and so Condition C is met.


Example 3 Mr B is a fitness instructor who provides his services through a company. After suffering an injury he winds up his company and starts work as a journalist. Mr B’s wife is also a fitness instructor and she offers her services as a sole trader, before and after the winding up of her husband’s company. Mr B provides no services to his wife’s business at all.

Mr B is not “involved with” a similar trade or activity after the winding up of the first company, even though his wife is.

2.1.4 Condition D – tax avoidance motive

Where conditions A, B and C are satisfied S396B will still not apply unless Condition D is also met. S396B applies Condition D where:

“it is reasonable to assume, having regard to all the circumstances, that –

1. The main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax, or

2. The winding up forms part of arrangements the main purpose or one of the main purposes of which is the avoidance or reduction of a charge to income tax”

Section 396B/404A (6) provides further guidance on the purpose test:

“The circumstances referred to in subsection (5) include in particular the fact that Condition C is met.”

S396B/404A (5) requires that regard is given “to all the circumstances”, whereas S396B/404A (6) states that the circumstances should be specifically considered in relation to the fact that Condition C is met. Consideration will therefore be given in particular to whether the tax advantage is a consequence of the winding-up and the continuing involvement with the same or a similar trade or activity.

Ultimately, the legislation is asking whether the individual that has received the distribution is continuing what amounts to the same business, having extracted the accumulated profits in a capital form. This is inevitably a question of judgment to be made on the basis of facts in individual cases. The following issues are likely to be relevant:

Is there a tax advantage, and if so, is its size consistent with a decision to wind-up a company to obtain it?

To what extent does the trade or activity carried on after the winding-up resemble the trade or activity carried on by the wound-up company?

What is the involvement in that trade or activity by the individual who received the distribution? To what extent have their working practices changed?

Are there any special circumstances? For example, is the individual merely supplying short-term consultancy to the new owners of the trade?


How much influence did the person that received the tax advantage have over the arrangements? Is it a reasonable inference that arrangements were entered into to secure this advantage?

Is there a pattern, for instance have previous companies with similar activities been wound-up?

What other factors might be present to lead to a decision to wind-up? Are these commercial and independent of tax benefits?

Are there any events apparently linked with the winding-up that might reasonably be taken into account? For example, was the only trade sold to a third party, leaving just the proceeds of the sale?

It is impossible to give an exhaustive list or comprehensive examples as individual facts and circumstances will be paramount. The aim is to establish whether it is reasonable to assume that the individual has wound-up a company as a way of converting into a capital transaction what would otherwise have been paid out as income. The essential question is whether an individual may reasonably be regarded as carrying on or continuing to be involved in the same business as before, having extracted the profits in a capital form.

6.3.5 Exclusions

There are two exclusions in S396B/404A (7) that apply even where all of the conditions of S396B/404A are met.

Distribution does not create chargeable gain

The first exclusion is for any amount up to which, if S396B/404A did not apply, there would be no gain accruing for Capital Gains Tax. This is to ensure that amounts that represent a return to the investor of their “base cost” are not taxed as a distribution.

Distribution of irredeemable shares/ Demergers

Sometimes a company is would up, but the shareholder received shares in a new company and that new company receives all of the assets of the old. Although it is arguable that there is a tax advantage here, the chargeable gains legislation provides an exemption for reconstructions of this type, and it is not the type of transaction that S396B/404A is aimed at preventing.

It follows that, to the extent that the distribution comprises irredeemable shares S396B/404A will not apply. This means the rule will not generally apply where, and to the extent that, the rules on chargeable gains mean that the individual shareholder is not treated as having disposed of their original shares.


7. CAPITAL TAX PLANNING USING EIS AND “SEED” EIS

7.1 Overview of Enterprise Investment Scheme (EIS)

The purpose of the Enterprise Investment Scheme (‘EIS’) is to encourage individuals to subscribe for shares in unquoted companies carrying on, or about to carry on, certain qualifying business activities. The scheme provides:

for those subscribers who are qualifying individuals, 30% (was 20%) income tax relief on subscriptions and also, if they hold the shares for a certain period, exemption from Capital Gains Tax

for any subscriber who reinvests a capital gain in such shares, CGT deferral relief.

for any subscriber who makes a loss on disposal of such shares, relief for the capital loss

Qualifying individuals are broadly individuals who have not previously been connected with, and who do not become connected with the company within a specified period. Many of the rules and Revenue interpretations placed on Qualifying Trading company status are common to both EIS and EMI, particularly those trades that are excluded activities.

7.2 Qualifying Trading Company

In order to be a qualifying company, a company must satisfy various conditions throughout the three year period, in particular either it must exist for the purposes of carrying on a qualifying trade or, for periods after 26 November 1996, it must be the parent company of a trading group. The company must not be under the control of another company, or of another company and any person or persons connected with that company acting together.

7.2.1 Fully Paid Up Shares

The issued share capital of the company must not, if it is to be a qualifying company, include any shares that are not fully paid up. That applies to both the nominal amount of the share capital and any premium payable. Where the shares are issued after 5 April 1998, this condition is replaced by one applying only to the shares on which relief is claimed.

7.2.2 Unquoted Company

The company must be an unquoted company at the time of issue of the EIS shares. This is defined as meaning a company none of whose shares, stocks, debentures or other securities are marketed to the general public.

Shares which are listed on the Alternative Investment Market of the Stock Exchange (AIM), or on OFEX, are regarded as unquoted, whereas the old Unlisted Securities Market (USM) counted as quoted. If, during a relevant period related to an issue of shares, shares or securities of a company are listed on an exchange which is later designated, the company continues to be classed as unquoted in relation to that particular issue of shares.

7.2.3 The Gross Assets Rule

There are upper limits on the size of the company invested in by reference to the size of its gross assets - in the case of a company with subsidiaries, the gross


assets of the company and its subsidiaries (excluding shares in, and loans to, those subsidiaries). Those limits are:

£15m (was £7m) immediately before the issue of the shares, and

£16m (was £8m) immediately after the issue.

All forms of property which appear on a company’s balance sheet are assets for the purpose of this rule. The Revenue have issued a Statement of Practice indicating that ordinarily they will determine the value of a company’s assets by reference to the values shown on its balance sheet - see Statement of Practice SP2/00.

7.2.4 Whether Activities are a Trade

The company or at least one of its qualifying subsidiaries must exist for the purpose of carrying on a qualifying trade and that trade must be carried on wholly or mainly in the United Kingdom. In deciding whether a business is a trade what matters is whether it is actually, or is treated for all purposes of the Taxes Acts as, a trade, not whether the profits from it are assessable under Case I. Thus concerns, such as quarries and gravel pits, whose profits arise out of land and which are brought into Case I by Section 55 ICTA 1988 are not necessarily trades; each case must be considered on its merits. The commercial letting of furnished holiday accommodation is not a trade despite the fact that it is treated as such for certain purposes.

7.2.5 Qualifying Trades

For a trade to be a qualifying trade, it must be conducted on a commercial basis and with a view to the realisation of profits. Subject to that, all trades are qualifying trades except those falling within the list of excluded activities below.

7.2.6 Excluded Activities

Trades are not qualifying trades if they consist of certain activities, or if such activities amount, in aggregate, to a ‘substantial part’ of them. Those activities are as follows:

dealing in land

dealing in commodities, futures

dealing in goods other than in the course of an ordinary trade of wholesale or retail distribution

dealing in shares, securities or other financial instruments

banking, insurance, money lending, debt factoring, hire purchase financing or other financial activities

oil extraction activities (but oil exploration is a qualifying business activity)

leasing, including the letting of assets on hire - subject to a waiver for certain lettings of ships on charter

receiving royalties or licence fees - subject to waivers in certain cases

providing legal or accountancy services The following additional exclusions were added in relation to shares issued after 16 March 1998:

property development

farming and market gardening

activities concerned with forestry and timber production


operating or managing hotels and similar establishments

operating or managing nursing homes and residential care homes

In addition the provision of services or facilities for any trade carried on by another person (other than the parent of the company), where that other trade consists to a substantial extent of any activities mentioned above and a controlling interest in that other trade is held by a person who also has a controlling interest in the trade carried on.

7.2.7 ‘Substantial Part’ of a Trade

Whether excluded activities mentioned amount in aggregate to ‘a substantial part’ of a trade is a matter of fact, to be decided in the light of all the relevant circumstances. No definition of the phrase is provided by the legislation but where, judged by any measure which is reasonable in the circumstances of the case (normally turnover or capital employed), such activities account for less than 20 per cent of the activities of the trade as a whole, they should not be regarded as amounting to a substantial part of the trade. The Inland Revenue Manuals provide the following additional guidance on specific activities.

7.3. Qualifying individuals for EIS

Income Tax relief is available only to individuals investing as such; it cannot be given to individuals acting in the capacity of trustees. However individuals are allowed to use any person as a nominee to subscribe for the shares, or be registered as the holder of them, on their behalf. Relief is also available in respect of joint subscriptions. There is no requirement that the individual should be resident in the United Kingdom, but of course relief can only be given to the extent that there would have been a liability to UK tax.

7.3.1 Qualifying investors

An individual will qualify for relief if he or she

is not ‘connected with’ the company at any time during the designated period (formerly the seven year period or, for shares issued before 6 April 1998, the five year relevant period), or

is so connected by virtue of being a paid director of the company, but qualifies as a “business angel”.

7.3.2 Connection with the company – employees, partners, directors

An individual is connected with a company if he or she, or any associate, is:

an employee or partner of, or

an employee of a partner of, or

a director of, or a director of a company which is a partner of the company, or of any company which is at any time in the three year straddling period (formerly the five year relevant period) a subsidiary of that company.

‘Director’ has the wide meaning given in the close companies legislation S417(5) ICTA88.


An individual is connected with a company as a director only if he receives a payment from the company other than a ‘permitted payment’, or becomes entitled to receive such a payment.

The rule is extended to cover payments made to the individual indirectly or made to his order or for his benefit. The rule is also extended to cover payments made by any ‘related person’.

7.3.3 Associates of Individuals

For the purpose of the relief an associate of an individual is

(a) a person in any of the following relationships to him (i) husband or wife (ii) parent or remoter forbear

(iii) child or remoter issue As regards (a) above, separated spouses should be regarded as associated with each other but divorced persons should not. Other relatives in (a)(ii) and (iii) 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.

7.3.4 Permitted Payments

In determining whether a director is a paid director, certain payments are ignored. They are as follows:

any payment or reimbursement of expenses which are wholly, exclusively and necessarily incurred by the director in the performance of his duties

any interest which represents no more than a reasonable commercial return on the amount lent

any dividend or other distribution which does not exceed a normal return on the amount invested

any payment for the supply of goods which does not exceed their market value

any payment of rent which does not exceed a reasonable commercial rent

any reasonable and necessary remuneration which is paid for services rendered in the course of a trade or profession, other than secretarial or managerial services or services of a kind provided by the person to whom they are rendered, and is taken into account in the trading profits computation in respect of that trade or profession.

7.3.5 “Business Angels”

It was not intended to discourage investors who would like to become directors of the company they invest in (or of a subsidiary) and make their business expertise available to it. Such investors are often known as ‘business angels’. Business angels are allowed to qualify for Income Tax relief despite the fact that they receive payment for their services. However, the rule letting in business angels is tightly drawn. It applies only where the only way in which the individual is connected with the company following the investment is that he or she (or an associate) is a director who receives, or is entitled to receive, remuneration, and either:

at the time when the shares are issued, the director has never before been connected with the company in any way, or been involved in carrying on any


part of the trade now carried on by the company (or its subsidiary), whether as an owner of that trade or as a director or employee of the owner, or

the issue of shares is made within three years (for issues before 6 April 2000, five years) after a previous issue of eligible shares in respect of which the director satisfied the condition just mentioned.

For this purpose, ‘remuneration’ includes such items as benefits, and the remuneration must be reasonable in amount.

7.3.6 Connection with the company – the 30 per cent test

An individual is connected with a company if he or she, whether alone or together with any associate, directly or indirectly possesses, or is entitled to acquire

more than 30 per cent of the issued ordinary share capital of the company or any subsidiary

more than 30 per cent of the voting power in the company or any subsidiary, or

such rights as would, either in the event of a winding up or in any other circumstances, entitle the individual to receive more than 30 per cent of the assets of the company which would then be available for distribution to equity holders of the company.

7.4 Seed EIS (SEIS)

7.4.1 SEIS Income tax relief at 50%

The new Seed EIS provides a 50 per cent income tax relief on investments in

small early stage companies carrying on, or preparing to carry on, a new

business in a qualifying trade starting from April 2012.

SEIS income tax relief is available in respect of investments in shares in new

(two years old or less) smaller companies (those with 25 or fewer employees

and assets of up to £200,000). The company must be carrying on, or preparing to

carry on, a new business in a qualifying trade, and must not have previously

raised money under the EIS or VCT (venture capital trust) schemes.

The income tax relief is available on total investments up to £150,000 per company. To give the greatest degree of flexibility, this will be a cumulative limit, not an annual limit. For individual investors there is an annual limit on the amount of qualifying investments of £100,000.

Income tax relief is not available where the individual is an employee of the company (unless they are also a director), or has a more than 30% interest in it (for this purpose, no account is taken of loan stock).

In addition to the SEIS income tax relief, there was a capital gains tax (CGT) exemption for gains realised in 2012/13 and then invested through SEIS in the same year. (This exemption is separate from the CGT disposal relief that will apply to gains on disposals of SEIS shares.)

7.4.2 Seed EIS now permanent FA 2013 Sections 56 and 57

The income tax relief for investment in qualifying Seed EIS companies was originally scheduled to continue until 5 April 2017 and the CGT relief for reinvested gains was due to end on 5 April 2013, however it was announced in Budget 2014 that the relief has now been made permanent.


The relief continues to be available only to individuals and not to other persons, such as companies or the trustees of settlements.

To be entitled to the exemption the individual will have to make a qualifying disposal and a qualifying investment (or one or more qualifying investments) in the tax year. Qualifying disposal The individual must dispose of an asset in 2015/16 and the gain must arise on that disposal. There is no limitation on the type of asset that may be disposed of. All types of disposal, including part disposals, will qualify. Qualifying investment The individual must invest in shares in respect of which they receive income tax relief under SEIS. The shares must be subscribed for wholly in cash, fully paid up at the time of issue, and held for 3 years. Like normal EIS if income tax relief is not due the CGT exemption will not be available. A qualifying Seed EIS company is broadly a small (less than £200,000 gross assets) start up (share issue within 2 years of commencement of trading) company. The new form of the relief will only exempt half of the gains made from 2013/14 onwards and thus will only provide an effective 14% CGT saving. Example 7 (based on HMRC example) Catherine sold an asset in June 2016 for £200,000 and realised a chargeable gain (before exemption) of £80,000. If Catherine makes qualifying investments of at least £80,000 in SEIS shares in 2016/17, and all other conditions are met, half of the £80,000 gain will be exempt from CGT. Note that she does not need to invest the whole £200,000 sale proceeds in order to get the 50% exemption. In addition she would deduct £40,000 from her income tax liability (50% of the amount invested).

7.5 Seed EIS before EIS – and use the correct form!

GDR Food Technology Ltd v HMRC [2016] UKFTT

X-Wind Power Ltd v HMRC [2016] UKFTT

Seed EIS provides a 50% tax reducer for subscribers in small start-up companies, generally less than 2 years old with gross assets of no more than £200,000. Normal EIS provides 30% income tax relief. Both Seed EIS and normal EIS also provide generous CGT relief such as an exemption where the shares a disposed of after 3 years.

Only the first £150,000 of investment qualifies for the more generous Seed EIS and the timing of the investment is critical as normal EIS would then apply to any subsequent investment in the company, up to £5 million per annum.

GDR was incorporated in June 2013. In August it issued 42,856 £1 shares to two investors and completed forms for the enterprise investment scheme (EIS) and seed enterprise investment scheme (SEIS).

In September 2014, GDR’s accountant filed form EIS1 asking for HMRC's agreement that the shares qualified for EIS relief. HMRC Small Enterprise Centre authorised the relief in December 2014. The accountant then asked to withdraw


the EIS application on the ground that the form had been completed in error; instead the SEIS compliance form should have been submitted.

HMRC refused and the taxpayer appealed.

Referring to the similar case, X-Wind Power (2016), the First-tier Tribunal said the combination of the taxpayer issuing shares and submitting the EIS1 on the same day meant that EIS investment took place on 15 August. The requirement for SEIS in ITA 2007 s257DK that no EIS investment had been made by the issuing company on or before the day on which the shares were issued was not met.

The judge expressed sympathy that a 'small mistake' had led to 'significant financial consequences', but the law was clear. As stated by the tribunal in X-Wind Power, the legislation did 'not ask why a compliance statement under ITA 2007 s205 has been made, it simply asks whether it has been made'.

In the X-Wind Power case the directors cut corners on professional advice by completing the forms for SEIS approval themselves. In September 2012 investors subscribed for £90,000 of new shares on the basis that they would receive SEIS. However the company submitted a compliance statement to HMRC on form EIS1 instead of using the correct SEIS1 form. HMRC granted approval for EIS3 certificates to be issued to the investors. In April 2014 the company submitted the correct SEIS1 form to HMRC for approval of second round of SEIS investment. HMRC denied SEIS approval as it had previously given EIS approval. Note that a company can only use SEIS before EIS and this rule still applies even though the original rule that the SEIS funds must be applied before EIS finance can be raised has been relaxed.

In both cases the taxpayer's appeal was dismissed.

It is hoped that the new CGT investors relief introduced in the latest Finance Bill will not have such compliance traps.

7.6 Paying 20% CGT Instead Of 28% On The Sale Of Property

The latest Finance Act has retained the 28% CGT rate for sales of residential property, whereas the general rate was reduced to 20% for higher rate taxpayers. It has been suggested that it is possible to reduce the rate from 28% to 20% by deferring the gain temporarily into qualifying EIS company shares.

The tax planning opportunity arises because reinvesting the property gain in Enterprise Investment Scheme (EIS) company shares defers the gain until the shares are sold when the gain comes back into charge at the general rate of CGT, currently 20% for a higher rate taxpayer.

There is no minimum holding period for EIS deferral relief, however where the investor is seeking income tax relief and CGT exemption on the sale of the shares they need to be an unconnected investor and retain the EIS shares for at least 3 years.

The reinvestment in EIS shares must take place during the period of 12 months before to 36 months after the date of disposal of the property.

Example 8

Cliff sells a buy to let property in November 2016 for £300,000 making a capital gain of £100,000.


Cliff reinvests the £100,000 gain in shares in a qualifying EIS company with which he had no connection in January 2017. The £100,000 gain would be deferred until the EIS shares are sold and the £28,000 CGT liability for 2016/17 would not need to be paid.

As an unconnected investor Cliff will be able to deduct £30,000 (30%) from his 2016/17 income tax liability if he retains the shares for 3 years. The net cost of the EIS shares is thus £70,000.

Cliff decides to sell the EIS company shares in February 2020 for £105,000. The £5,000 gain on the EIS company shares would be exempt from CGT and under the current rules the £100,000 deferred gain comes back into charge at the general rate 20%, so just £20,000 CGT is then payable.

Shares in EIS qualifying companies are risky investments and specialist investment advice should be taken. There is also a risk that HMRC may block this tax planning strategy in the future.


8. IHT REFRESHER AND BASIC PLANNING

8.1 Inheritance Tax Overview

Inheritance tax is a flat rate tax of 40% that broadly applies to the value of assets owned by the deceased at the date of death in excess of the nil rate band. This nil rate band is currently £325,000 (2009/10) and will be frozen at this level until at least 2020/21. Inheritance tax at 40% also applies to gifts and other transfers made by the deceased in the 7 years prior to death (including potentially exempt transfers or PETs), and there is a lower rate of 20% that applies to certain transfers into trusts. Certain assets and transactions are exempt from inheritance tax, notably gifts of any assets to the spouse and to charities and political parties. Business assets including certain shareholdings may also attract business property relief at the rate of 100% or 50%. Shares in AIM listed companies if certain conditions are satisfied may attract 100% relief. Apart from very exceptional circumstances, shares in a company with a full Stock Exchange listing are not eligible for business property relief. be acting for most of these.

8.2 Take Advantage of Lifetime Exemptions

The following transfers during a taxpayer’s lifetime are exempt from inheritance tax and should be utilised as part of basic inheritance tax planning:

Annual exemption £3,000 (can be carried forward one year if unused)

Small gifts exemption £250 per donee per annum

Gifts to spouse

Gifts to political parties and charities

Normal expenditure out of income (see below).

Gifts for Family Maintenance etc.

Gifts in consideration of marriage

8.3 Inheritance Tax on gifts between spouses

Generally a transfer from one spouse to another whilst they are married is exempt from inheritance tax. This is provided the recipient is UK domiciled at the time of the gift. Where the recipient is non UK domiciled the exemption is now limited to £325,000 (was £55,000). The same exemption now applies to gifts between civil partners. This spouse exemption applies to both lifelime transfers and transfers on death and would also apply to assets thansferred to a interest in possession trust for the benefit of the other spouse during lifetime and on death (such as a will trust for surviving spouse).

8.4 Reduced IHT rate if leave 10% to charity

A reduced rate of 36% is now charged where 10% or more of a deceased person’s “baseline amount” (broadly the net estate after deducting IHT exemptions, reliefs and the nil rate band apart from the charitable legacy itself) is left to charity. The measure applies where death occurs after 5 April 2012.


Example 9 George, a single man, is terminally ill and is considering making a substantial donation to various charities in his will. He has not made any transfers during his lifetime and has an estate worth £2,325,000. The balance of his estate will be left to his brother Henry. If he does not make any charitable bequests he would leave a chargeable estate of £2,000,000 after the £325,000 nil rate band. This would mean an IHT liability of £800,000 leaving a net estate of £1,525,000 to his brother Henry. If instead George decides to leave £200,000 to his chosen charities the chargeable estate would be reduced to £1,800,000 and the IHT rate would be reduced to 36% reducing the IHT liability to £648,000. Henry’s net estate would then be £1,477,000. The £200,000 charitable bequest therefore reduces the IHT liability by £152,000 = 76%. Paragraph 3 of Schedule 1A divides the estate into three parts or ‘components’ for the purposes of the new Schedule 1A: survivorship, settled property and general. Paragraphs 3(2) to (4) define the property that is included in each of the components:

1. The survivorship component is made up of property which passes automatically to a surviving joint owner.

2. The settled property component consists of assets in certain trusts in which the deceased had a life interest or right to income immediately before their death.

3. The general component includes all other property that makes up a person’s estate, including the free estate, which is not part of the survivorship or settled property components. This does not include gifts where the deceased continued to benefit from the property given away. Such property cannot qualify for the reduced rate.

The 10 per cent test will be applied to each component separately and the lower rate will apply to those components that pass the test unless an election is made to opt out. Where a charitable legacy from one or more components of the estate exceeds the 10 per cent minimum it will be possible, by election, to combine components and apply the 10 per cent test to the aggregate. Where the aggregate components meet the test, the lower rate will apply to the merged components. This will enable the benefit from charitable legacies of more than 10 per cent to be spread to other parts of the estate.

8.5 Gifts out of Income?

Nadin v IRC 1997 SpC 112

The deceased, who was relatively wealthy, had been living in a nursing home for a number of years. Her income was just over £18,000 and the nursing fees about £13,000. It was assumed that the balance had been utilised in the payment of tax and personal expenses. Accordingly when she gifted more than £270,000 out of income previously accumulated, the Revenue and the Commissioners were unable to accept that it satisfied the conditions for “normal expenditure out of income”.

Section 21 IHTA 1984

In earlier years other gifts had been made and whilst some of the conditions were satisfied (namely that they had been made out of the deceased’s income and that allowing for the transfers, the deceased had been left with sufficient income to maintain her usual standard of living) the emphasis of the Revenue’s argument changed towards whether or not the gifts had been made as part of the normal


expenditure of the transferor. Unfortunately, the gifts were of an irregular amount and to various individuals.

8.6 Potentially Exempt Transfers (PETs)

Up until Budget Day 2006 (22 March 2006) the following transfers were treated as potentially exempt from inheritance tax, in other words provided the donor lived for 7 years following the gift or transfer the transfer would be completely exempt:

Outright gifts to an individual;

Transfers to an interest in possession (IIP) or life interest trust;

Transfers to an Accumulation and Maintenance Trust (A&M).

Gifts to a trust for the benefit of a disabled person. Note however that from 22 March 2006 transfers to interest in possession trusts and certain A&M trusts are no longer PETs but chargeable at the time of transfer.

8.7 Chargeable Lifetime Transfers

A chargeable transfer is any transfer of value other than an exempt transfer. Up until 22 March 2006 the most common examples were transfers into discretionary trusts and transfers of value by close companies. From 22 March 2006 transfers to interest in possession trusts and certain A&M trusts are no longer PETs and would therefore be chargeable to inheritance tax at the time of the transfer. The lifetime IHT rate is 20% after the nil rate band has been used.

8.8 Cumulation – Interaction of Lifetime and Death Rates

The IHT nil rate band is applied to chargeable lifetime transfers on a cumulative basis, with transfers in the previous 7 years being taken into consideration in computing the tax payable on the present transfer.

8.9 Inheritance tax taper relief

As shown above where the transferor dies within 7 years of the transfer the tax is recomputed at death rates, but the tax payable is tapered in accordance with the following table: Years between transfers and death percentage of full tax rate 3 years or less 100% 3 – 4 years 80% 4 – 5 years 60% 5 – 6 years 40% 6 – 7 years 20%

The interaction between the concepts of life time gifts which are PETs and those which are chargeable not only has the above problem but is complex and is best illustrated by an example.

Example 10 Mr Andrews is a relatively wealthy individual. He has made or makes the following gifts etc:

i) in 2007, he gives £145,000 to a discretionary trust for his son ii) in 2011, he makes another gift of £325,000 to his daughter iii) in 2016, he dies leaving an estate of £450,000

No IHT is due during his lifetime on the above gifts (annual exemptions have been utilised on the first day of each year by the appropriate small gifts).


On death, tax will be due on both the failed PET (payable by his daughter) and the estate held at death as follows: a) Failed PET:

Gift to daughter 325,000 Gifts in previous 7 years 145,000 470,000 Nil band 325,000 Chargeable on Death 145,000 Tax @ 40% 58,000 Less taper relief @ 40% 23,200 Payable £34,800

b) On his estate:

Estate at Death 450,000 Gifts in last 7 years 325,000 775,000 Less nil band 325,000 450,000 Tax @ 40% 180,000

This example illustrates the 14 year window for Capital Tax planning. The gift in 2007, some 8/9 years prior to the death clearly affects the total tax "take" at death. This indicates a general principle of staging Capital Tax planning in 8 yearly tranches.

8.10 Transfer of the IHT Nil Rate Band to Spouse

Legislation in Finance Act 2008 effectively doubles the nil rate band for married couples without the need for complicated trust planning. The unused element of the nil-rate band, currently £325,000 per individual, will become transferable to a surviving spouse (or civil partner). This will apply on the death of a surviving spouse or partner after 8 October 2007, regardless of when the first death occurred. The amount of the nil rate band available for transfer will be based on the proportion of the nil rate band that was unused when the first spouse or partner died. The unused proportion will be applied to the amount of the nil rate band in force at the date of the surviving spouse or partner’s death. For example, Mr A died October 2007 leaving his children £100,000 (one-third of the then nil rate band) with the rest of his estate passing to his wife. On Mrs A’s subsequent death, her nil rate band will then be increased by two-thirds. So, if the nil rate band at the time of Mrs A’s death is £360,000, she will be able to leave £600,000 free of inheritance tax, i.e. £360,000 plus £240,000 (two-thirds of £360,000). If a person marries more than once, the nil rate band of the survivor can generally only be increased by a maximum of 100%. The legislation makes it clear (Section 8A(3) IHTA 1984) that it is necessary to claim this relief. Section 8B lays out the time limits. There is no need to claim on the first of a husband/wife civil partnership. The claim must be made within two years of the second death by the PRs or if later, 3 months from when they start to


act for the estate. If they do not claim, then a claim can be made by any other person who could be liable to the Inheritance tax payable on the occasion of the second death (ie order of offset for failed PETs made by the survivor). This does have implications for file storage and info retention to enable the PRs to know what did happen what could be a long time ago, even today given the retrospection involved. It is arguable that this change makes no real difference to the current position where couples will often make use of nil-rate band discretionary trusts to effectively preserve the nil-rate band. However, this route looks far simpler than the trust route but care should be taken to balance the simplification that it offers against the growth in value that could accrue outside of the estate of the surviving spouse if investment growth continues. Great care needs to be taken where the first death occurred before 13 March 1975 (ie under Estate Duty) when the rules were very different. The new legislation confirms that the use of IPDI (Will Trust) to the surviving spouse will not effect the situation as that falls within the inter-spouse exemption. It also confirms that S144 IHTA appointments from nil band trusts to the surviving spouse could be used to take advantage of this simplified route if that is considered to be the best route where the death occurs before the will can be amended. Care needs to be taken why the trustees exercised this power to appoint to the surviving spouse (after 3 months but within two years of the death) due to the growth in value point made above.

8.11 Additional Main Residence Nil Rate Band (RNRB)

The normal £325,000 nil band is insufficient to shelter the value of many homes from IHT, so the Government is introducing a new additional nil rate band to be applied only to the value of a home left on death to a direct descendant of the deceased. This home-related nil rate band will start at £100,000 per person from April 2017 and increase over four years to £175,000 per person, allowing a couple to eventually pass on a family home worth up to £1m with no IHT (2 x £325,000 plus 2 x £175,000). The home-related nil rate band will not apply in full if the total estate is worth over £2m, and will not apply to a house that has never been used as a residence by the deceased (e.g. a buy-to-let property). If the net value of the estate (after deducting any liabilities but before reliefs and exemptions) is above £2 million, the additional nil-rate band will be tapered away by £1 for every £2 that the net value exceeds that amount. The taper threshold at which the additional nil-rate band is gradually withdrawn will rise in line with CPI from 2021/22 onwards. A direct descendant will be a child (including a step-child, adopted child or foster child) of the deceased and their lineal descendants. A claim will have to be made on the death of a person's surviving spouse or civil partner to transfer any unused proportion of the additional nil-rate band unused by the person on their death, in the same way that the existing nil-rate band can be transferred. Where after 8 July 2015 someone downsizes their home, or ceases to own a home, thus turning the IHT-relieved property into cash, assets of an equivalent value will also be eligible for the relief. Like the nil rate band any unused allowance can be transferred to a surviving spouse or civil Partner.


Withdrawing the extra residential allowance from high value estates, whilst understandable in policy terms, nevertheless imposes an effective 60% marginal ‘step rate’ of tax in those cases. Although the overall, true effective rate will never exceed 40%, such distortions are the antithesis of simplicity. It also poses problems for people with Business and Agricultural assets and those who make charitable bequests as these would be included in the gross estate. Example 11 Mr Brunt owns his family home worth £900,000 and a shareholding in his family trading company worth £5 million. Even though 100% Business Property Relief is potentially available, leaving a net chargeable estate of £900,000 the relevant value for the purpose of the Main Residence nil band is £5.9 million and as such there would be no allowance in addition to the normal £325,000 nil band. Complexities will exist even for individuals without businesses: Example 12 Mr and Mrs Morrison have assets worth £3,000,000, including the family home worth £2,000,000 and savings etc. worth £1,000,000, all owned equally. On the Mr Morrison’s death there is entitlement to the family home allowance as the deceased had an estate of less than £2,000,000 (i.e. the interest in the house worth £1,000,000 and the share of the savings etc. worth £500,000 = £1.5 million). The family home allowance would appear to be transferable to the surviving spouse on the first death. Assuming that the surviving spouse Mrs Morrison inherits the entire estate, due to this inheritance, she has an estate of £3,000,000 so that on her death, no family home allowance accrues and it appears likely that there would be no benefit from the unused allowance from the first spouse’s death as the family home allowance on the second death would be increased by the unused proportion from the first death i.e. the family home on the second death would be doubled to reflect the unused allowance on the first death. This gives no relief as it is 200% of £Nil.

8.12 “Downsizing” to a Cheaper Property

The RNRB will apply where the residence is sold (or is no longer owned) on or after 8 July 2015. This proposal will ensure there is no disincentive to downsize or sell a home from the date the RNRB was announced.

The proposal would apply to situations where the deceased:

downsized to a less valuable residence and that residence, together with assets of an equivalent value to the ‘lost’ RNRB, has been left to direct descendants

sold their only residence, and the sale proceeds, or other assets of an equivalent value, have been left to direct descendants

has otherwise ceased to own their only residence, and other assets of an equivalent value have been left to direct descendants

The broad intention is that an estate would be eligible for the proportion of the RNRB that is foregone as a result of downsizing or disposal of the property as an addition to the RNRB that can be used on death. For the purposes of this note this will be referred to as the ‘additional RNRB’.

The qualifying conditions for the additional RNRB would be broadly the same as those for the RNRB, that is the:


individual dies on or after 6 April 2017

property disposed of must have been owned by the individual and it would have qualified for the RNRB had the individual retained it

less valuable property, or other assets of an equivalent value if the property has been disposed of, are in the deceased’s estate (this would also include assets which are deemed to be part of a person’s estate)

less valuable property, and any other assets of an equivalent value, are inherited by the individual’s direct descendants on that person’s death - direct descendants are the same as those in relation to the RNRB

In addition, the following conditions would also apply:

the downsizing or the disposal of the property occurs after 8 July 2015

subject to the condition above, there would be no time limit on the period in which the downsizing or the disposals took place before death

there could be any number of downsizing moves between 8 July 2015 and the date of death of the individual

downsizing would also include disposing of part of a property (including land occupied and used as a garden or grounds) or a share in it

where a property is given away, assets of an equivalent value to the value of the property when the gift was made must be left to direct descendants

the value of the property would be the net value i.e. after deducting any mortgage or other debts charged on the property

the additional RNRB would be tapered away in the same way as the RNRB if the value of the estate at death is above £2m

the additional RNRB would be applied together with the available RNRB but the total for the two would still be capped so that they would not exceed the limit of the total available RNRB for a particular year

a claim would have to be made for the additional RNRB in a similar way that a claim is made to transfer any unused RNRB to the estate of a surviving spouse or civil partner

The HMRC technical note included the following examples:

Example 1 A widow sells a home worth £400,000 in August 2020 and moves to a home worth £210,000. At the time of the sale the available RNRB is £350,000 as, had she died at that time, her executors would be able to make a claim to transfer all the unused RNRB from her late husband. By downsizing, she has potentially lost the chance to use £140,000 or 40% of the available RNRB which could have applied had the more valuable home not been sold. When the widow later dies in October 2020, the home is worth £225,000 and is left to her children together with £500,000 of other assets. The estate can use an RNRB of £225,000. However, the widow was eligible for an RNRB of £350,000 had she not downsized. The estate can therefore claim an additional RNRB of 40% of the available RNRB (40% x £350,000) or £140,000. This would give a total RNRB of £365,000 (£225,000 + £140,000). But this is more than the maximum available RNRB (£350,000) so the additional RNRB is restricted to £125,000 to ensure that the total amount used does not exceed the maximum available. In addition, the existing nil-rate band together with any transferable nil-rate band claimed from her late husband’s estate can be applied to the remaining assets in the estate.


Example 2 A husband sells a home worth £300,000 in July 2020 and moves to a home worth £140,000. At the time the available RNRB is £175,000. He has potentially lost the chance to use £35,000 or 20% of the available RNRB which could have applied had the more valuable home not been sold. When he dies in December 2020, the home is worth £175,000 and is left to his son with the remainder of the estate passing to his wife. The estate can use the RNRB of £175,000 to the full and since the RNRB was fully used on death, there is none to transfer to the widow. However, none of the existing nil-rate band has been used, so it can be transferred and will be available on the widow’s death along with her own RNRB. Example 3 A widower gives away his home worth £400,000 to his children in May 2020 and moves into rented ‘later living’ accommodation. At the time of the gift the available RNRB is £350,000. He has potentially lost the chance to use £350,000 or 100% of the available RNRB which could have applied had he not given away his home. When he dies in February 2021, within 7 years of the gift, his estate is worth £600,000 and is split between his four children. As there is no qualifying residence in his estate, it cannot use RNRB directly. But the estate is eligible for additional RNRB up to the maximum 100% of the available RNRB at his death or £350,000. The position for the gift of the house is considered first. RNRB only applies to the assets in the estate, so it is not available in respect of the gift of the house. However, the estate can claim the full transferable nil-rate band (TNRB) of £650,000 so there is no tax to pay on the gift of £400,000. The balance of £250,000 TNRB remains available to be set against the estate. RNRB is applied first against the estate of £600,000, leaving a remainder of £250,000. The balance of TNRB from his late wife’s estate is applied to this amount so no tax is payable as a result of the death.

8.13 Business Property Relief

The transfer of business assets, including certain shareholdings, during lifetime or on death attract business property relief at the rate of 100% or 50% . The Inheritance Tax Act 1984 sets out two basic conditions which must be observed in order for business property relief to be available:


1. The property transferred must be relevant business property. 2. The property must have been owned throughout the two years prior to

the transfer.


The “replacement property” rule means that although the particular business property has been owned for less than 2 years it will still qualify for relief where that property replaced other qualifying business property and the two assets together have been owned for at least 2 years in the 5 years prior to the relevant disposal.

8.13.1 Relevant business property

Business property relief is only given on relevant business property and this can be divided in to seven main categories. (a) A business or an interest in a business. (b) Shares or security giving control in a "company".


(c) Shares giving control of the quoted company. (d) Unquoted shares not covered in the above that gave the transferor more

than 25%. (e) Unquoted shares not covered above. (f) Land buildings, plant and machinery etc owned by the transferor which

immediately before the transfer were used wholly or mainly for the purposes of the business carried on either by: (i) A company controlled by the transferor or (ii) A partnership in which the transferor is a partner.

The current rates are as follows: Category of Business Property 19.3.92 to 6.

4.96 6.4.96

onwards % % Business Interests (self employed and partnership

100 100

Control holding (unquoted) 100 100 Control holding (quoted) 50 50 Minority Interests: (up to 25% of equity) (over 25% of equity)

50 100

100 100

Fixed assets made privately but used by controlled Co or partnership

50 50

Note that AIM shares are unquoted for business property relief.

8.13.2 Meaning of relevant business property

Generally the relief covers business property but care must be taken where investments etc are held. Relief is not available where the business consists wholly or mainly of one or more of the following:- 1. Dealing in shares or securities. 2. Dealing in land or buildings. 3. Making or holding investment.

Section 105 (3) IHTA 1984

It should be pointed out that the legislation indicates that relief is only available where the business of the company does not consist wholly or mainly of the precluded activity set out above. Note that “wholly or mainly” means greater than 50% and there has been significant case law in this area, particularly cases involving caravan parks where the Revenue have contended that the business comprises wholly or mainly an investment activity. This is a looser requirement than the 80/20 test required for CGT trading company status and means that a company with say 60% trading and 40% investment activities would still be entitled to IHT business property relief (albeit restricted by excepted assets) whereas that same shareholding may be ineligible for business asset taper. BPR is not available in respect of landlord activities and furnished holiday accommodation activity. There are however special commissioners decisions in


favour of the tax payer where it is clear that the tax payer was carrying on significantly more than just letting activities. The properties are indeed considered part of a property management business. Where farm land is involved, see APR below. The other area that needs to be considered is that BPR only applies to property consisting of a business or an interest in a business. It is not simply sufficient to dispose of a business asset.

8.14 Danger Areas Regarding BPR and APR

8.14.1 PETs becoming chargeable

Although it may appear that business property relief is available against the lifetime transfer of a business asset such as shares, under certain circumstances the relief may be withdrawn if certain conditions are not satisfied at the date of death. There are two additional conditions which need to be satisfied when tax potentially becomes due as a result of a PET and the transferor dies within seven years or the transferor dies within seven years having made a chargeable transfer to say a Discretionary Trust. The conditions are the business property must either have been owned by the transferee throughout the period up to the date of death or have been replaced by other property or as far as the transferee is concerned the property must be qualifying business property throughout the period up to the date of death

Section 113A IHTA 1984

Example 13 Fred gave his friend Barney 100,000 ordinary shares (a 10% stake) in Bedrock plc, an AIM listed trading company, worth £5 a share in March 2012 Fred, who had owned the Bedrock plc shares for at least 2 years prior to the gift, died in April 2017. It would appear from the above that although the PET becomes chargeable as a result of the death within 7 years, 100% BPR would provide full relief from inheritance tax on the £500,000 transfer. However BPR would be denied under two sets of circumstances: 1. If Barney sold the shares in the period between the date of gift and the date

of death and did not reinvest in replacement business property. 2. If the Bedrock plc shares were retained, but failed to qualify as relevant

business property, for example if the company had obtained a full SE listing in the period prior to death. Note that a 10% holding in a fully listed company attracts no BPR at all.

Thus the PET would be chargeable and the value transferred would be £500,000 less annual and other exemptions. The value of the shares at death would only be used if the shares had fallen in value and the time interval was less than 3 years. In the above situations the beneficiaries should be warned to keep sufficient life assurance (see later) to cover any liability that may arise on the transferor's death within seven years.

8.14.2 Existence of Excepted Assets from BPR

Business property relief is only available on business assets. Where a company has excepted assets (investments mainly) or is an investment company there are still ways in which value can be transferred. The importance of good


documentary evidence where a trading company requires high levels of liquidity and/or cash reserves to justify the retention of the funds in the company cannot be stressed enough. The Barclays Bank Trust Company case provides the courts’ interpretation of the excepted assets rule where the company has significant amounts of cash on deposit, in excess of what was necessary for working capital purposes.

8.14.3 Binding Contracts for sale

Relief will be denied in its entirety where a binding contract for the sale of property is in existence at the date of transfer (either on death or lifetime gift) which requires shareholders or partners to sell their share of the partnership or their shares in the company to the remaining shareholders/partners either by the partnership deed, the Articles or Association or other binding agreements. It totally negates the availability of business property relief. All agreements must be reviewed to ensure that such provisions do not exist and cannot be construed. The position is easily avoided by inserting the appropriate options although great care must be taken with their wording. Options could include:

SP 12/80 ICAEW Memorandum TR557

1. The personal representatives of the deceased to require the

existing shareholders/partners to buy the deceased shares or 2. The shareholders would have the option to require the deceased

personal representatives to sell their shares/share of the business to the existing shareholder.

Often there will be key man type policies to provide the appropriate funds to enable the buy out to occur. Great care must be taken to ensure that the wording does not create binding contracts for sales.

8.14.4 Business Property Relief and Diversification

In the recession many farmers and other businesses have been diversifying into other areas such as renting out surplus premises in order to keep afloat. However there is a risk that too much diversification may jeopardise the availability of IHT business property relief as where the activity constitutes wholly or mainly the making or holding of investments (more than 50%) then no relief would be due.

2020 innovation capital taxes update and planning

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