Entrepreneurs relief (ER) is a valuable relief, which reduces the rate of capital gains tax (CGT) payable on a qualifying business to 10%. It is only available to individual and not companies, and only applies to qualifying disposals of business assets. An individual has a ‘lifetime allowance’ and can only claim relief in relation to their available individual lifetime allowance after taking previous disposals into account at the date of the disposal. Gains in excess of the lifetime allowance are taxed at the applicable CGT rate for the period in which the disposal takes place.
Depending on the type of business asset, different forms of ER apply:
- Sole Traders or Partners: (i) ER can apply to the disposal of the Business or Part of the Business; or (ii) disposal of the assets of the business following its cessation.
- Officer or employee Shareholders: ER can apply to the disposal of shares or securities in a company.
In this article we are focusing on the application of ER in an ‘Officer or Employee Shareholding’ disposal.
Disposals on or after 6 April 2019
For disposals made on or after 6 April 2019 to qualify for ER, the Company in question must be classified as a trading company or part of a trading group - as investment companies do not qualify for ER – and the company must be a trading business or part of a trading group throughout the two-year period of ownership (previously 12 months).
The individual must then hold in that company at least 5% of the ordinary share capital and be entitled to 5% of the distributable profits and 5% of the rights to assets in a winding up or an entitlement to at least 5% of the sales proceeds on the disposal of the ordinary share capital of the company for disposals on or after 28th October 2018.
Trading business or trading group
First we must look at the expression ’trading business’. This means a company carrying on trading activities whose activities do not include to a substantial extent (i.e. in practice, more than 20%) activities other than trading activities. Trading takes its normal meaning in tax and means any venture in the nature of trade. Similarly, a trading group includes a non-trading holding company whose only activity is holding shares in a trading company.
This definition is not particularly helpful and has probably led to confusion as to what constitutes a trading company, especially in relation to cash rich companies. It is a bear trap that continues to trip up practitioners and lay people alike, as confusion continue overs what is law or what is perceived as law.
A case in point, HMRC‘s own consultation document published on 9 December 2015, refers to cash rich companies, and is where the term “moneyboxing” appears. This consultation documentation was on the back of changes to dividend taxation, however the recommendations referred were not fully implemented. Consequently, confusion continues to be written, surrounding cash rich trading companies or “Money Box” companies.
We need to look at the substance, the commerciality of the situation, what it is we are examining. Or to put in broad simplistic terms, can we not state, that if a Company has the attributes of a trading company and acts, like a trading company, it generally is a trading company.
The Duck Test
“It is often said that, if something looks like a duck, walks like a duck and quacks like a duck, the balance of probability is that the thing before you is a duck.” Therefore, if the company looks like a trading company, and feels like a trading company and there is no compelling reason why it should not be treated as a trading company. (Slevin, 2012). Instead, we apply a commercial purpose and look at the reasons and rationale for holding cash, as the mere holding of cash does not negate the argument that the company is a trading company. Fortunately, tax cases do offer some guidance.
In Jowett v O'Neill and Brennan Construction  STC 482, a case about small company corporation tax relief, it was held that holding substantial sums of money in a deposit account did not amount to an activity. The significance being that having a surplus of cash should not automatically mean that a company is involved in any investment activities, and for cash to become an investment activity it requires some form of investment management.
The most recent First-tier Tribunal case of Potter  UKFTT 554 (TC), asks in what circumstances can investment activity lead to the loss of ER. Paragraphs 84 and 85 of the judgment set out the answer:
84 The asset and income position of the company are factors against trading activities. The expenses incurred and time spent by the directors/employees are factors pointing to trading activities. When one stands back and looks at the activities of the company as a whole and asks “what is this company actually doing?” the answer is that the activities of the company are entirely trading activities directed at reviving the company’s trade and putting it in a position to take advantage of the gradual improvement in global financial conditions.
85 Having carefully considered all the evidence and circumstances I find that the activities of the company did not, to a substantial extent, include activities other than trading activities.
Once could argue that this goes a long way to enforce the duck test argument. As with most things, the devil is in the detail or, in this case, the quality of the duck being served.