Examining the definition of ‘trading’ in CGT reliefs and asking if entrepreneurs’ relief will continue to exist.
The October 2019 ruling of the First Tier Tribunal in Potter provided clarification that what constitutes trading for the purposes of entrepreneurs’ relief extends to other CGT reliefs for both individuals and companies, such as substantial shareholding exemption or holdover relief.
In Potter vs. HMRC, HMRC attempted to deny Entrepreneur’s Relief on liquidated company shares of Mr and Mrs Potter, who were directors and shareholders of Gatebright Ltd, a company trading as a broker on the London Metal Exchange.
The facts of the case were that as a result of the 2008 financial crisis Gatebright suffered a significant decline in sales whilst at the same time investing 80% of available reserves in two six-year investment bonds, generating significant dividend income.
Although the economic recovery followed and efforts to broker deals continued, progress was slow due to director’s ill health, resulting in the last sales invoice being issued in March 2009.
In November 2015 the directors liquidated the company and claimed entrepreneur’s relief. HMRC denied entrepreneurs' relief on the grounds that:
the company had ceased trading when the last invoice was issued (2009) and outside the three year period (before November 2012) in condition B in section 169I of TCGA92
the investment of reserves in the bonds meant that the company's activities had become investment activities.
The taxpayers appealed HMRC's decision.
The tribunal rejected HMRC’s arguments and ruled that:
trading activities did not cease in 2009 due to no sales being secured after this date. Activities carried out after 2009 amounted to trading activities: seeking new business, preparing the ground for the continuance of trade once market conditions improved
temporarily suspension of activities due to Mr Potter's ill-health did not mean that Gatebright ceased trading
investment in corporate bonds was not considered a significant non-trading activity as the company spent no time, money or effort on those activities. When considering activities as a whole, the FTT found that they did not, to a substantial extent, include activities other than trading activities.
Impact of the decision
The ruling reaffirmed the meaning of a ‘trading company’ per section 165A CGTA92: the essence of a trading status for a company is in whether trading activities are carried out, rather than how effective they are and a temporary suspension of trading activities due to circumstances beyond control is not sufficient to determine that trading has ceased.
As the status of trading has a broader relevance in tax law, the impact of the Potters' case is likely to help in cases involving holdover relief or substantial shareholding exemption.
Taking active steps to maximise investment returns, for example actively moving funds between high interest bearing accounts to maximise returns, taking planned investment risks or incurring costs on investment advice are likely to constitute significant non-trading activities. However, merely placing funds in a financial product does not, even if the amounts invested represent a significant proportion of company funds and most income the company generates comes from the investment.
Finally, the government has highlighted that entrepreneurs’ relief is under review. The Conservative Party manifesto said entrepreneurs’ relief would be reviewed and reformed. The PM in The Times stated:
‘Boris Johnson has signalled that a tax break for entrepreneurs is likely to be scrapped in the budget because it is merely making already “staggeringly rich” people even wealthier.
The Prime Minister said that the Treasury was vehemently against entrepreneurs’ relief, which saved company owners and investors £2.4bn in 2018 by allowing them to cut their tax bills when they sold their ventures.’