Author: Stephen Burwood

All three of the main Political Parties included a commitment in their pre 2019 General Election manifestos to either abolish or “review and reform” entrepreneurs’ relief (ER). This sounds like the death knell for ER to apply to the proceeds from company liquidation.

There may be opportunities to take advantage of Entrepreneurs’ relief now to protect the position should the availability of relief be compromised.

However, before any action is taken it would be prudent to ensure that relief would in fact be due and that all the conditions have been in place for the required 24 months prior to the disposal. In particular :

Unincorporated Businesses

For an unincorporated business who owned what proportion of the business, and for which periods? For ER to apply there is a 5% ownership threshold to meet for company and partnership shares, although this is subject to variations for retiring partners and diluted shareholdings.

Periods of low activity

The Potter case, examined whether a period of very low activity with no actual sales could be considered to be trading. The FTT decided the minimal activity was trading, and crucially there was no investment activity in that period, so the Potters’ ER claim was upheld.

Where the trade wound down it may have changed location or nature in the last few years. In that case it can be difficult to define exactly when the trade ceased. This problem was examined in the Jeremy Rice case.

Property Letting – Trading?

Letting out property is nearly always regarded as an investment activity rather than trading, so where the business has been letting property you need to look for other activities which could be trading. The recent case of Stephen & Lynne Reneaux illustrates this problem.

The couple jointly owned two commercial units which were used for Stephen’s business until 2003. For the next 10 years the income from letting the units was reported as rental income inequal shares on the couple’s tax returns. The units were sold in 2013, and the individuals both claimed entrepreneurs’ relief on their share of the gain.

The FTT looked for substantial activity associated with the letting of the units which could be regarded as a trade, but concluded that the activities required to generate income from the units did not amount to a trade. The ER claims were rejected.

FA 2019, Schedule 16 has introduced four changes to entrepreneurs’ relief (ER). The new conditions for an individual’s shareholding in their personal company to qualify for ER took effect from 28 October 2018. The three other changes to ER take effect for disposals made after 5 April 2019.

Qualification period

For disposals after 5 April 2019 all the qualifying conditions for ER must be in place for at least 24 months to the date of disposal, or to the date the business ceases to trade.

Look through incorporation

Where a business incorporates the qualification clock for the ER conditions is set back to zero on the issue of the shares, or on date the on which the company starts trading, whichever is the later. Where the shareholders receive an offer for the company shortly after incorporation, they will be denied ER as they won’t have built up full qualification period of share ownership.

For disposals after 5 April 2019 the qualification period for ER can look through the incorporation and include the period during which the unincorporated business was owned by the current shareholders. This look-through only applies if the shares were acquired wholly or partly in exchange for the transfer of the business as a going concern, and all the assets of the business, other than cash, must have been transferred to the company. These are the conditions under which incorporation relief applies.

If it is planned to incorporate the business, make sure that incorporation relief does apply as an insurance policy against a quick sale of the company.

Dilution of shareholding

Where equity investment is raised from outside investors, it can dilute the holdings of existing shareholders to below 5% of ordinary share capital, stripping away their rights to ER.

For new share issues made from 6 April 2019, the existing shareholders can preserve their ER by making two elections . The first election creates a deemed sale and reacquisition of their shares, crystallising the gain on which ER can be claimed, and the second election defers the CGT due until their shares are sold. These elections must be made by the first anniversary of 31 January following the tax year in which the additional shares are issued.

A little knowledge is a dangerous thing, especially in tax. The circumstances of a transaction need to fit precisely within the parameters of the relief, or tax will be payable as is demonstrated by the cases of CF Day v HMRC and KW Day v HMRC

Mr and Mrs Day sold a plot of land for £200,000, and reinvested the proceeds in a cottage which they planned to let out as holiday accommodation. Mr Day did not take professional advice, but instead did some online research, which he didn’t print off or bookmark, so he couldn’t refer back to it.

From his research, Day believed that CGT rollover relief would be due, as he was selling a business asset (land he farmed) and buying another business asset (a Furnished Holiday Lettings property). In fact business asset rollover relief (TCGA 1992, s 152) was not available to Mr Day as the cottage was subsequently let on 6-month tenancies and not as short term furnished holiday accommodation, so it didn’t qualify as a business asset.

Mrs Day was the joint owner of the land, but she didn’t farm the land, as the farming business was carried on by Mr Day alone as a sole-trader. Thus, for Mrs Day, neither the asset disposed of (farm land), nor the asset acquired (the cottage), qualified as business assets.

Having reached their erroneous conclusions about CGT rollover relief, the couple thought that no tax would be payable on the sale of the land, so they didn’t report the transaction on their tax returns. HMRC investigated and raised assessments for the CGT due, plus penalties for careless errors on the tax returns, and interest due on late paid tax.

Amazingly, HMRC accepted Mr Day’s claim for entrepreneurs’ relief on his share of the gain, which cut his CGT liability by half. Unfortunately, Mrs Day was not eligible to claim entrepreneurs’ relief as she was not farming the land.

Private residence relief provides relief from capital gains tax arising on the disposal of a property which has been the taxpayer’s only or main residence.

In the recent tribunal decision of Hezi Yechiel TC06829, consideration was given as to whether, for the purposes of the legislation, Mr Yechiel occupied the property in question, 6 Beaufort Drive, as his only or main residence.

In determining whether the property was occupied as a main residence, the Tribunal considered the ordinary English meaning of ‘reside’ which is ‘to dwell permanently or for a considerable period of time, to have one’s usual or settled abode, to live in a particular place’.

In determining whether a property qualifies as a `residence’, the nature, quality, length and circumstance of the occupation are taken into account. Weight is also given to the taxpayer’s intention – in this case to have a ‘bolt hole’ to escape the stress of his divorce and for it to be a long-term home.

The tribunal considered what Mr Yechiel did in the house. It had a working kitchen and bedroom and (the Tribunal presumed) a bathroom. While Mr Yechiel slept there, he did not cook there or do his washing there; when he ate there, it was mainly take-way food. He brought only a bed and a side table for the property. During the period Mr Yechiel spent a significant amount of time at his parents’ house, eating there and doing his laundry there.

The Tribunal dismissed Mr Yechiel’s appeal. They found his occupation lacked sufficient quality of occupation, concluding ‘that to have a quality of residence, the occupation of the house should constitute not only sleeping, but also periods of ‘living’, being cooking, eating a meal sitting down, and generally spending some periods of leisure there.

It is important that clients appreciate the quality of occupation as well as the quantity when seeking to claim private residence relief.

Tribunal decision Hezi Yechiel TC06829