Investment or trading? It matters when you want to sell
In our last article we considered the practical aspects of preparing a business for sale. Here we look at the tax reliefs available on sale and how property developers can inadvertently lose out.
Business Asset Disposal Relief (formally Entrepreneurs’ Relief) is a Capital Gains Tax relief potentially allowing up to £1m of gains during your lifetime to be taxed at a rate of 10%, instead of the standard rate of 20%. Qualifying for Business Asset Disposal Relief can therefore save up to £100,000 per person.
Disposal of shares
When looking at the disposal of shares in a company, one of the requirements of the relief is that the shares being disposed of are in a ‘personal’ trading company. This means holding at least 5% of the company’s ordinary share capital, having 5% of the voting rights and in broad terms having 5% of the economic value of the company for 24 months leading up to a disposal.
Business Asset Disposal Relief (BADR)
Business Asset Disposal Relief considers a trading company to be one that does not have ‘substantial’ non-trading activities, and in this context HMRC considers substantial to be 20%. When considering the non-trading activities of the company we have to look at asset value, turnover, profitability and management time.
Property investment companies are not trading for Business Asset Disposal Relief purposes as the receipt of rental income is considered a non-trading activity. Property development companies, however, are regarded as trading, but this position can easily become blurred where unsold properties are retained for letting.
Retaining properties for rental
If you retain properties for rental within your development company, documenting why will be vitally important. HMRC will assess the intention of the directors, taking account of market conditions. Shorter-term lets, during a period when it is not possible, or commercially unattractive to sell, will help demonstrate that the investment activities are incidental to the main trade, although HMRC may not agree the company has retained its trading status.
Another issue facing property companies is that they may, over time, have built up substantial cash reserves representing more than 20% of the balance sheet value of the company.
It is recognised that certain companies will need significant working capital because of the nature of their business, or have retained profits from trading activities, and this may not prevent Business Asset Disposal Relief from being claimed. However, HMRC will view each case on its particular facts.
It is worth noting that, generally, the company must have been a trading company throughout the 24 months leading up to the disposal: simply distributing cash shortly before a sale, or stopping letting properties, will not be a solution if the company is susceptible to being challenged on its trading status.
If the conditions for Business Asset Disposal Relief are not met, none of the gain on the shares will qualify for relief, and will be taxed at the standard rate of 20%.
In addition to thinking about the availability of Business Asset Disposal Relief on a sale of a company, we need to consider Business Property Relief.
Business Property Relief (BPR)
Business Property Relief is another valuable relief that can reduce the Inheritance Tax due on a chargeable transaction, whether a lifetime gift or on death. Shares in unquoted trading companies that have been owned for at least 2 years can qualify for 100% relief from Inheritance Tax.
The test of whether a company is a trading company is different to that for Business Asset Disposal Relief. For BPR purposes, the company must not be engaged wholly or mainly in the making of investments or dealing in land and buildings. The test for BPR is therefore a 50% test.
Factors taken into account when considering Business Asset Disposal Relief (asset value, turnover, profit and management time) also apply to BPR.
As with Business Asset Disposal Relief, if the company is not a trading company BPR is not available at all.
Deciding whether a company is trading, and therefore qualifies for Business Asset Disposal Relief and/or Business Property Relief can be complex, and we would recommend that you seek advice before taking decisions that could affect your ability to claim these very valuable reliefs.
Further information on BDAR is available from HMRC here.
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