Can a business that hasn't started to trade qualify for a key tax relief?

Background

In 2014, W, alongside two others, established a general partnership, whose business was to develop, construct and operate renewable power plants at three locations in the UK. The partnership began to undertake pre-trading activities in May 2014.

At a time when the partnership had not commenced trading, it sold two plants to a third party, in August 2015 and November 2015. W reported the disposals on his tax return and claimed entrepreneurs’ relief (ER). HMRC denied the claim. ER has since been renamed business asset disposal relief (BADR), but the same legislation applies.

Points in question

The amount of capital gains in question was not disputed. Rather, the only issue to decide was whether an individual partner was entitled to claim ER on the disposal by a partnership of some or all of its business, when that partnership had not commenced trading.

At the First-tier Tribunal (FTT) in Wardle v HMRC [2021] TC8105, W argued that the disposal constituted a material disposal of business assets. However, and assuming all other conditions were met, the main dispute was whether there was a “business”, defined as anything which is:

• a trade, profession or vocation; and
• conducted on a commercial basis and with a view to the realisation of profits.

The appeal hinged on whether the partnership’s business activities fell within the definition of “a business” for ER purposes, given that they had been disposed of prior to the commencement of trading, when the business was being set up.

The FTT agreed with HMRC. In particular, it noted that the “natural and ordinary” meaning of the definition of “a business” is that it requires that an individual or partnership making the disposal to be disposing of something that is, at that time, a trade, and is conducted, at that time, on a commercial basis. In other words, ER did not extend, in the circumstances of this case, to pre-trading activities.

Applicable points 

While W’s appeal was unsuccessful, it’s important to note that it is possible for a company that is pre-trading to claim BADR , where all other relevant conditions are satisfied. This is because s.165A(4) Taxation of Chargeable Gains Act 1992 gives specific mention to pre-trading activities as being within the definition of “trading activities”. 

The provision means that sharegolders can potentially claim BADR on a disposal of shares (rather than assets) in a company that has not yet commenced trading.

It will, however, be important not to mistakenly incorporate a partnership shortly before a disposal to try to bring a gain within BADR - the shares will be subject to the two-year holding period. It would be better to ensure at least some commercial activity takes place so a trade exists to remove any doubt.