Article by Adrian Rudd of PricewaterhouseCoopers, the Tax Adviser representative on the Technical Committee, on CIOT representations concerning proposals in the pre-Budget report to extend the scope of business asset taper relief to employee shares in non-trading companies (published in the March issue of Tax Adviser). Problems with the ‘trading company’ test
The Institute has previously drawn attention to the practical difficulties in applying the definition of a trading company for taper relief purposes. Taxpayers and practitioners find it an imprecise definition, because it requires consideration of the purposes for which a company exists. Moreover, if there is more than one purpose, it is necessary to determine which purposes are capable of having a substantial effect on the extent of the company’s activities (TCGA 1992, Sch A1, para 22(1)).
Where employee shareholdings are concerned it may be especially difficult for the shareholder to apply this test, particularly where an employee’s holding is a minority and/or where there is a group situation requiring the consideration of the activities of the group as a whole. Employees may simply be unable to obtain enough information to apply the test correctly. The Institute has advocated the use of a definition similar to that which applies for the purpose of Inheritance Tax business property relief, which is that the company’s business should not consist wholly or mainly of making or holding investments and certain related activities (IHTA 1984, s. 105(3)).
At first sight, therefore, the suggestion that the trading company test might be dispensed with for employee holdings is an attractive one which offers the prospect of simpler compliance. There seems to be no reason in principle why employees of non-trading companies, which may generate substantial shareholder value and provide significant employment, should not benefit from enhanced taper relief.
Problems with the alternative ‘close company’ test
Whilst the Institute recognises the need for revenue protection measures, there are two objections to excluding the employees of non-trading companies which are close:
1. This may merely substitute one complex definition – that of a close company – for another, and therefore do little to simplify taxpayer compliance. If a company is close to the boundary both of the trading and close company definitions, the proposal adds another unfortunate area of uncertainty to the one which already exists. Like trading status defined according to the existing definition, close company status can change from day to day and employees with small shareholdings may find it difficult to monitor. Also, in some listed companies, the question whether they are close or not can be especially unclear, although it has ceased to be relevant for most other purposes.
2. The effects of adopting close status as the boundary may be capricious. From the viewpoint of junior employees who are a shareholders in, say, a listed property group, it may seem particularly unfair that they cannot obtain business taper relief merely because their employer happens to be close, whereas comparable shareholders/employees in a competitor group obtain it merely because their group is ‘open’. If business taper relief is intended to act as an incentive to encourage employees to take a stake in their companies (to quote from the opening words of the Press Release), it seems illogical to base the existence of this incentive on factors over which employees may have no control.
An alternative suggestion – size of shareholding
For those reasons the Institute called for the revenue protection measures to be founded on a test which is simple to apply, objective and related directly to matters within an employee’s knowledge and control. The obvious solution would be to base the test on the size of an employee’s shareholding, including for this purpose any holdings of their associates. A threshold of 20 per cent would seem appropriate, to discourage securitisation of assets within a corporate envelope. For holdings of this level or below, business taper relief would be due to employees and officers whether or not the trading test was satisfied. Close status, or otherwise, would be irrelevant. Where a holding of more than 20 per cent was disposed of, an apportionment could be made giving business taper to the extent that it had at any earlier stage been part of a less than 20 per cent holding.
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