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Busy Practitioner by Mark McLaughlin CTA (Fellow) ATT TEP

Mark McLaughlin CTA (Fellow) ATT TEP, General Editor of TaxationWeb, warns that HMRC’s current policy and practice on capital gains tax taper relief will be less than helpful for some taxpayers.

Companies and cash balances

An announcement by HM Revenue & Customs (HMRC) in Tax Bulletin 84 (August 2006) regarding changes to the facility for obtaining company status rulings (i.e. whether a company was a trading company or the holding company of a trading group) was quickly superceded by guidance in the Capital Gains Manual at CG 17953r.

It should be noted that whilst much of the Capital Gains Manual guidance on the status of a ‘trading company’ or holding company of a ‘trading group’ dates back to 2003, certain paragraphs have changed more recently despite the fact that the legislation defining those terms (TCGA 1992, Sch A1 paras 22A and 22B) has remained unaltered since they were introduced by Finance Act 2002. In general, practitioners should remain alert to changes made to the HMRC Manuals, which are notified on their website. When relying on that guidance, it should be printed off and date stamped.

A particular concern for many trading companies or groups is the extent to which surplus cash retained from trading activities can jeopardise trading status. The Capital Gains Manual at 17953i (one of the paragraphs in the taper relief guidance on trading company or group status to have changed earlier this year) states:

“…the long term retention of significant cash generated from trading activities may amount to an investment activity. Factors to consider include the present and future cash flow requirements of the business, the nature of the underlying investments used as a lodgement for the funds, the extent to which these investments are managed and whether the funds have been ear-marked for a particular use in the trading activity.”

HMRC’s view on the potential for retained cash to affect trading company or group status had been expressed in a Corporation Tax Operational Consultative Committee (CTOCC) meeting between HMRC and representatives of the professional bodies in September 2005. The Chartered Institute of Taxation (CIOT) had raised concerns about inconsistency in business asset taper relief rulings in relation to shares from local area offices. The CTOCC meeting minutes (available on the HMRC website at http://www.hmrc.gov.uk/ctsa/ctocc-21-09-05.htm) state: “One inspector was reported to have said that she had received instructions from Head Office to challenge all companies where there is a lot of cash on the balance sheet. CIOT wished to know if inspectors had separate unpublished guidance and whether all requests could be dealt with by the Business Tax Clearance Team to ensure a consistent approach.” HMRC provided reassurance that “Inspectors have certainly not been asked to challenge all large holdings of cash. HMRC think that it will often be the case that a reserve of undistributed profit on deposit could not be said to constitute an activity in itself” but went of to say: “However, there may be an investment activity where the amounts involved are significant relative to the trading activity and are held over a long term.”

Many practitioners will have client companies with substantial amounts of retained cash on deposit, which has not been earmarked for a particular trading purpose, or paid out as dividends. Some practitioners will also be familiar with applying to HMRC for rulings on trading company or group status. My own experience of doing so is that trading company or group status was generally accepted more freely by local inspectors in the early days of the application procedure, despite surplus cash in some cases representing well in excess of 20% of assets considered to be ‘substantial’, being one of the tests set out in the Capital Gains Manual at CG 17953p. However, more recently surplus cash has proved to be something of a stumbling block. The resulting inconsistency and uncertainty has seemingly discouraged some practitioners (me included) from applying for status rulings in those cases.

Status applications

In any event, the circumstances in which HMRC will give taper relief trading status rulings has been significantly narrowed down following the Tax Bulletin 84 announcement. Previously, it was possible to apply to HMRC for a ruling under Code of Practice 10 (COP 10) on the status of a company for a particular period. However, HMRC will now only provide a post-transaction ruling, where shareholders have made a disposal. The Capital Gains Manual at 17953r has been amended accordingly, and now states:

“In some circumstances a significant number of shareholders may need to know the status of a company after making disposals of shares AND where the company itself has genuine doubt or difficulty as to its trading status. In such circumstances, the company may seek a post-transaction ruling from its Officer of Revenue and Customs for the assistance of the individual shareholders.”

The company status ruling facility that preceded the above change was not without its difficulties, as indicated earlier. However, it was better than no facility at all. The change will leave some shareholders with uncertainty as to the tax position in respect of their shares even after a disposal, particularly smaller family or owner-managed companies, where the number of shareholders is not ‘significant’. In those cases, CG 17953r states: “They will need to take a view and make their self-assessment return on this basis.” If the company is unwilling or unable to confirm whether it was a trading company (or holding company of a trading group) and a post-transaction ruling is not possible, taxpayers will need to make full disclosure of their ‘view’ in the ‘white space’ on the tax return, stating why they consider the company to be a trading company and business asset taper relief to be due, if appropriate. HMRC will no doubt make enquiries into taper relief claims, and their conclusions will be subject to the normal self-assessment appeal procedures, if appropriate.

Presumably, COP 10 applications on company status demanded greater HMRC resources than making formal enquiries. However, pre-transaction rulings could generally be dealt with cost-efficiently without protracted correspondence. Even if a post-transaction status application under COP 10 is possible, practitioners should note that HMRC will not enter into correspondence having expressed their view on the matter (CG 17953r). The only remedy for an unsatisfactory ruling would therefore appear to be full disclosure on the relevant tax return (i.e. as for those taxpayers for whom a COP 10 application was not available, but stating the outcome of that application), and possibly to appeal arising out of an HMRC enquiry.

Mark McLaughlin CTA (Fellow) ATT TEP
November 2006

The above article is taken from ‘Busy Practitioner’, a monthly journal from Tottel Publishing. To order a subscription to ‘Busy Practitioner’, click here