Trading company or the holding company of a trading group

For entrepreneurs’ relief to be available on sale / gift of shares or securities, the company must be trading (or the holding company of a trading group). A trading company is 'a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities' TCGA 1992, s 169S(4A) as read with TCGA 1992, s 165A

An activity is carried on in the course of, or for the purposes of, a trade if it is carried on in the process of conducting or preparing to carry on the trade. This is discussed further in CG64060. TCGA 1992, s 165A(4)

The term ‘substantial extent’ is not defined in the legislation, but HMRC consider substantial to be ‘more than 20%’. CG64090

The so-called ‘20% test’ is applied to a number of different criteria depending on the facts and circumstances of each case, including:

·  turnover

·  asset base / balance sheet

·  expenses incurred by the company

·  directors’ time

It is clear from CG64090 that HMRC will look at all the facts and circumstances “in the round” when making a decision as to whether the company is trading using the approach set out in the IHT case Farmer and another (executors of Farmer, deceased) v Inland Revenue Commissioners [1999] STC (SCD) 321 (subscription sensitive).

The impact of each of the measures should be weighed up in the context of each case. However, HMRC do not consider the following to be non-trading activities55—

• (a)     letting of part of the premises;

(b)     letting properties no longer required for the purpose of the trade in question where the company's objective is to sell the premises;

(c)     subletting property where it would be impractical or uneconomic in terms of the trade to assign or surrender the lease;

•  (d)     acquisition of property with the intention to bring it into use for the trade.

In IRC v George56 it was suggested that the following facts should be considered to determine trading status—

(1)     the overall context of the business;

•  (2)     capital employed;

•  (3)     employer time;

•  (4)     turnover; and

•  (5)     profits. ·         ( HMRC will not seek to apply the test if the company had a particularly poor trading period. Without this, a company with seasonal trading fluctuations (for example) might not be considered a trading company.

However, it is not clear from HMRC’s manuals that this practice of ignoring a poor trading period can be extrapolated to encompass an extended amount of time (eg downturn due to recession). It is recommended in uncertain cases that a non-statutory business clearance application is made to HMRC for a trading status ruling on behalf of the company. For guidance on clearances see the Drafting clearance applications guidance note.

CG64100

The following manuals discuss HMRC’s view of what constitutes an investment:

·  •shares held otherwise than as investments (CG64080)

·  •surplus trading property (CG64085)

From 18 March 2015, the activities of a joint venture company are no longer treated as activities of the shareholder company. Similarly, activities carried on by a partnership of which a company is a member are also not treated as activities of that company. A 'joint venture company' is a trading company where at least 75% of the ordinary shares are held by five persons or less and the shareholder company (or the group as a whole) owns at least 10% of ordinary shares. FA 2015, s 43 as read with TCGA 1995, s 165A; Explanatory notes, s 43. A more detailed discussion of this issue can be found here

Even if the company appears to be 'cash-rich', it may still be considered a trading company depending on the underlying facts. For example, a company which has placed cash on a deposit or money market account may not prevent the company from being a trading company even if the amounts involved are significant. Also, money placed with a stockbroker for investment may not be an indication of investment activity if the intention is retain the funds in a comparatively liquid form rather than tied up in long-term investments. It is a good idea to scrutinise the terms of engagement with the stockbroker and the instructions provided by the company when deciding whether the investment strategy was long-term. Again, it might be a good idea to make a non-statutory business clearance application to HMRC for a trading status ruling on behalf of the company in these circumstances.

The position of cash-rich companies is discussed further in 'The duck test ' by Kevin Slevin in Taxation magazine on 7 November 2012 (subscription sensitive).

Planning point
As the entrepreneurs' relief rules only consider a one year period in which the company must satisfy the trading status rules it is important to watch for loss of trading status on family companies and to warn directors and shareholders of the consequences. Where a company has genuine doubt or difficulty as to its trading status it can seek an opinion from HMRC using the non-statutory clearance service57