This year’s Budget has not been very kind to entrepreneurs’ relief, the 10% tax rate that applies when an individual sells a business. We’ve already seen in last year’s Autumn Statement, the introduction of rules to restrict the relief when a business incorporates. This year’s Budget saw two more measures aimed at people intending to access the relief when they shouldn’t be.
In this article we shall look at the new rule on joint ventures and partnerships. What was the law before the Budget, what is the law now, and why was the law changed?
Joint venture and partnership holdings to be disregarded in determining trading status
This measure is aimed at individuals holding shares in a trading company or holding company of a trading group. In order to qualify for the relief, it is necessary to hold at least 5% of the company’s share capital, together with the requisite voting rights. However, by using the rules on joint ventures and partnerships, a person could access the relief even though his effective stake in the underlying trade was far less than this figure.
This was possible because the rules permitted one to look through the joint venture or partnership and attribute the underlying trade to the corporate vehicle in which the individual held his shares. This will not longer be the case from 18 March 2015.
Let’s now take a closer look at the legislation to see how this works.
The ground rules – what are the conditions for individuals holding shares?
Where a person holds his stake in a business through a corporate vehicle, the following conditions are required1:
- The company must be a trading company or holding company of a trading group (the trading test);
- The individual must own at least 5% of the ordinary share capital, together with 5% of the company’s voting rights. In these circumstances, the company is his personal company; and
- He must be an employee or officer of the company, or, if the company is a holding company, it is sufficient to be an employee or officer of any group member.
All three conditions must be satisfied for a one year period until he sells his shares. If the trading test fails, all is not completely lost. Provided certain conditions hold, the 10% rate will continue to be available for another three years2.
For the trading test to be satisfied, a single company is a trading company if its activities are substantially trading activities3. A group is a trading group if the group’s activities taken as a whole, are substantially trading activities4. The latter condition recognises the fact that in substance a group is a single economic unit.
One issue arising when a company holds an interest in another vehicle is whether this amounts to a trading activity. While this can be the case in some circumstances, the usual position is that a holding in a company is regarded as an investment if the stake falls short of the 51% required to be a group member5. However, there used to be special rules for joint venture and partnership holdings as we shall now see.
What were the rules on joint ventures?
If the company or group had a holding of more than 10% in the joint venture company, it was permissible to look through into the underlying trade. In particular, the holding of the joint venture shares were disregarded as a separate activity, and the appropriate portion of the underlying trading activities attributed to the company or group6. It was therefore possible to have a single company which had no assets apart from its joint venture holding. This company would be regarded as a trading company even though it had no trade of its own.
To see how this could be used to circumvent the personal company test, first note the definition of a joint venture company7:
- A joint venture company is a trading company or the holding company of a trading group;
- At least 75% of the share capital of the company must be held by not more than five persons. Where any of these persons include fellow group members, their holdings are aggregated as if they were a single entity.
For example, consider a joint venture company with five corporate owners, each holding equal shares. Each shareholder has a 20% stake, and can therefore appropriate 20% of the joint venture’s relevant trading activities. Note however that one can hold a 10% stake without being one of the five whose holdings make the company a joint venture. For example five people holding 15% each make up 75% of the share capital – any company holding 10% of the remainder was entitled to apply the look through rule.
Now consider an individual holding a 5% stake in his personal company, which in turn holds only shares in a joint venture company. Suppose also that it is the minimum 10% holding. The individual’s interest in the underlying business is 5% of 10% or 0.5%. This is the stake he would have if instead, he held shares directly in the joint venture company. Accordingly he qualifies for entrepreneurs’ relief even though his stake is effectively far less than the 5% required.
That is, he used to qualify. Not any more. From now on, the company’s trading status will no longer be determined by looking through to the underlying trade of the joint venture8.
There is an additional consequence of abolishing the joint venture rule. The old rule stated that the actual holding of the joint venture shares as an activity in itself, should be disregarded. But now, it will be required to consider the shareholding in its own right and ask the question “Is it an investment or a trading activity?”
What were the rules on partnerships?
Unlike joint ventures, there has never been any explicit provision permitting a corporate member to look through and appropriate the partnership’s trading activities. However, as far as common law partnerships are concerned, one can argue that such a provision was not needed. If we look at the CGT provision that attributes partnership gains to the individual partners, the opening words state9:
“Where 2 or more persons carry on a trade or business in partnership…”
So it is implicit that the partners themselves are trading. Accordingly, where the company or group has a share in a common law partnership, it should be regarded as trading in its own right. Of course, this is no longer the case for the purpose of entrepreneurs’ relief – from now on, the partnership’s trading activities must be disregarded10.
The position is not so clear in the case of an LLP. This has its own separate legal personality – the corresponding CGT provision attributing LLP gains to its members makes clear that the trade is that of the LLP11:
“Where a limited liability partnership carries on a trade or business with a view to profit…”
So the LLP’s trade cannot be considered as the trade of its members, unless it is deemed to be so by the legislation. Can we find such a deeming provision?
Further down the legislation we find12:
“(b) any dealings by the limited liability partnership are treated for those purposes as dealings by its members in partnership (and not by the limited partnership as such)…”
At first this would appear to give some support to the view that one can appropriate the relevant part of the LLP’s trade. The dealings of the LLP are the dealings of its own members. However, dealings are not necessarily the same as activities, and one also needs to put this part of the legislation in context.
The whole subsection reads:
“Where a limited liability partnership carries on a trade or business with a view to profit –
(a) assets held by the limited liability partnership shall be treated for the purposes of tax in respect of chargeable gains as held by its members as partners, and
(b) any dealings by the limited liability partnership shall be treated for those purposes as dealings by its members in partnership (and not by the limited liability partnership as such),
and tax in respect of chargeable gains accruing to the members of the limited liability partnership on the disposal of any of its assets shall be assessed and charged on them separately.”
If one considers the passages before and after the highlighted part (b), one sees that dealings must refer to dealings in the assets that are held by the LLP. This reflects the purpose of this particular subsection, which is to attribute the LLP’s gain to its members. This does not necessarily imply that the activities of the LLP constitute the activities of the members.
Is there anything else in the legislation that can help us?
The other option is to rely on the provision that states that references to partnerships are to include LLPs13. Does this mean that one can read into the earlier provision for common law partnerships:
“Where 2 or more persons carry on a trade or business in partnership…”
And deem that members of an LLP are to be treated as carrying on a trade? It is not at all clear that this statutory interpretation is correct – if it is implied, it is a weak implication.
In any event, it is all academic. For LLPs, it doesn’t matter if you couldn’t make the attribution before – you certainly can’t now.
Comparing joint ventures and partnerships – why are partnerships also excluded?
It is clear why the rules have been changed regarding joint ventures. If the individual held shares directly in the joint venture company, his stake would be far less than the required 5% and so he fails the personal company test.
But when one considers the partnership scenario it is not quite the same. On a big picture view, the new rules make sense – why discriminate between a joint venture and a partnership structure when in substance, they are both doing the same thing? However, it is not so clear when looking at the legislation.
When an individual holds a partnership interest, the transaction that gives rise to entrepreneurs’ relief is an asset sale, not a share sale14:
“at any time when a business is carried on by a partnership, the business is to be treated as owned by each individual who is at that time a member of the partnership.”
This ensures that entrepreneurs’ relief is available when the partnership sells the business. Alternatively the relief is available when a partner sells his own particular interest in the venture15:
“the disposal by an individual of the whole or part of the individual’s interest in the assets of a partnership is to be treated as a disposal by the individual of the whole or part of the business carried on by the partnership,…”
There is no requirement as to how large a stake that each partner must hold. Had the individual held the partnership stake directly, he would have been entitled to the relief. So where is the mischief in this case when the legislation does not require a minimum holding?
Sting in the tail – past trading status won’t help
These rules came into force on 18 March 201516. But what is the position of a company that would have been regarded as trading before this date, where trading status arose by virtue of its joint venture or partnership interests? Recall that there is a three year period in which the relief will still be available, even if the trading test has failed.
Sounds attractive, but that option has also been closed off. The three year rule will not apply in this situation. Those companies that satisfied the trading condition purely by virtue of their joint venture or partnership interests are considered never to have been trading at all17 – entrepreneurs’ relief is deemed never to have applied in the first place.
So that’s that!
- TCGA 1992 ss 169I(6), 169S(3). ↩
- TCGA 1992 s 169I(7). ↩
- TCGA 1992 ss 165A(3), 169S(5). ↩
- TCGA 1992 ss 165A(8), 169S(5). ↩
- Note that it is 51% not the usual 75% that applies for capital gains groups – TCGA 1992 ss 165A(14), 169S(5). ↩
- TCGA 1992 ss 165A(7), 165A(12) ↩
- TCGA 1992 s 165A(14). ↩
- TCGA 1992 s 169S(4A)(a) inserted by FA 2015 s 43(2). ↩
- TCGA 1992 s 59(1). ↩
- TCGA 1992 s 165(4A)(b), (c) inserted by FA 2015 s 43(2). ↩
- TCGA 1992 s 59A(1). ↩
- TCGA 1992 s 59A(1)(b). ↩
- TCGA 1992 s 59A(2). ↩
- TCGA 1992 s 169I(8)(c). ↩
- TCGA 1992 s 169I(8)(b). ↩
- FA 2015 s 43(5). ↩
- FA 2015 s 43(4). ↩
Latest posts by Satwaki Chanda (see all)
- Spring Budget 2017 – where are the documents? - Wednesday 8 March 2017
- Spring Budget 2017 announced Wednesday 8 March 2017 - Tuesday 20 December 2016
- Draft Finance Bill 2017 Documents are now available - Monday 5 December 2016