Nichola Ross Martin's Tax Consultancy

This is a quick guide designed to answer you FAQs on this topic.

Trade

“Trade” is defined for tax as "any venture in the nature of trade".

Over the years the courts have taken this to include a trade, manufacture, adventure or concern in the nature of trade. The term is “commonly used to denote operations of a commercial character by which the trader provides to customers for reward some kind of goods or services".

Many different activities are described as trading. The “badges of trade” are accepted by the courts as a reasonable way of establishing whether a transaction was trading or capital in nature.

The badges of trade:

1. The subject matter of the realisation.
2. The length of the period of ownership.
3. The frequency or number of similar transactions by the same person.
4. Supplementary work on or in connection with the property realised.
5. The circumstances that was responsible for the realisation.
6. Motive.

A trading company is a company engaged in a trade, and a trading group is a group of companies whose activities are wholly or mainly trading ones, as opposed to investment activities. For groups and capital gains, the % of the shareholdings in the subsidiaries is important. Capital gains tax groups require 51% holdings.
A holding company which is not trading but which sits on top of trading companies will itself be treated as part of the trading group.

Business

Business is defined more broadly than trade. Whilst a trade is a business, not all businesses are trades. Businesses may take many shapes or forms, and to quote Lord Diplock in the case of Town Investments Ltd v Department of the Environment [1978] AC 359, “the word “business” is an etymological chameleon; it suits its meaning to the context in which it is found”.

An investment business

An investment business tends not to have the same advantages for tax as a trading one.

A company that is in the business of holding and passively managing investments is taxed as an "investment business". The key feature is that for tax the allowable expenses will be limited to those required for investment management. This type of company will be taxed at main tax rates if it is a close investment holding company (CIHC).

A business of holding land and property for rental is described by ITTOIA 2005 as a "property rental business". This description is slightly misleading.

• A property rental business is not regarded as a business for the purposes of IHT business property relief and CGT business asset relief (whether unincorporated or incorporated): it is regarded as the holding and managing of investments.
• A property business will only be treated as a business for IHT and CGT if it is actively managed and there is more to the business than just letting.
• A company which holds rental property will not be a CIHC unless its property is let to a connected party.

A furnished holiday letting business (FHL) is a type of property business that is treated as if it is a trade across all the taxes.

Why is it important to distinguish between a trade and a business?

Income and corporation tax

Certain reliefs are only available if a person carries on either a business or a trade. Confuse the terms and there may be no tax relief.

For example:
An individual can obtain tax relief when he makes a loan made to a close company , one qualifying condition is that the close company uses it wholly and exclusively for the purposes of its business.
"Business" may in this context include lending money to another company (if this furthers the aim of the close company), as the courts agree that this can amount to "its business".

If the money is used for the purposes of a passive investment activity such as property letting relief could be denied. It may be for the courts to decide and it will definitely depend on the facts of any given case, but past case law in IHT and CGT cases indicates not.

Where there are mixed activities, or where a company has been dormant, it is important to review what if any its activities are year on year.

Practical points on Holding, investment and dormant companies

A Holding company is not seen as carrying on a trade or business if all the following apply:

• It has no assets other than shares in companies which are its 51% subsidiaries; and
• It is not entitled to a deduction, as charges or management expenses, in respect of any outgoings; and
• It has no income or gains other than dividends which it has distributed in full to its shareholders and which are, or could be, franked investment income received by that company.

An investment company is a company carrying on a business of making investments, and not a trade, and so is not dormant.

A dormant company is not treated as an associate of another company under common control.

Is an investment company or holding company "dormant" or in “business”?

A company, which is not trading, but is managing cash in a deposit account, might be deemed to carrying on an investment business, depending upon the facts.

The case of Jowett v O'Neill and Brennan Construction Ltd [1998] STC 482 involved a company, which had ceased trading, but still maintained a bank deposit account. It was held not to be involved in investment business, and dormant for the purposes of associated companies.

This has to be contrasted to the Revenue’s view as expressed in its Statement of Practice 5/94, where interest receivable is not discussed. Its Inspectors may argue that holding companies are not dormant due to the existence of bank interest. The decision in O’Neill’ indicates that it depends on the facts of the case.

A more recent case is Salaried Persons Postal Loans Limited v. HMRC [2005] SPC 504. This involved a company which had ceased trading, and continued to rent out a freehold property. Unlike Jowett, there was no bank account - all transactions were done via an inter-company account with a group company. Despite being in receipt of investment income, from what can only be termed an investment property, it was held that the income was neither from investment business or any other sort of business. In short the company was dormant and not an associate.

Each case must be decided on its facts, clearly a company whose main trade has ceased will stand a better chance of persuading the Tribunal that it is dormant than one that is just temporarily not trading. It is important to also consider the main objects of a company. If its main object is to hold or manage investments, it will be difficult to say that even the tiniest piece of bank interest or rental income is not income from an investment business.

A Close Investment Holding Company will not worry about its own associated companies, because it is paying tax at the full rate because of its own tax status.

Capital gains tax

CGT Roll Over and Gift Relief and Entrepreneurs' Relief only apply on the disposal of business assets used in a qualifying trade, an interest in a trading partnership or the shares of a trading company or group.

Inheritance tax

IHT Business Property Relief can be claimed an interest in a business and on shareholdings of unquoted shares, but it is denied to investment partnerships and companies and those whose business consists “wholly or mainly” of one of the following:

Dealing in:

1. Shares or securities
2. Land or buildings
3. Making or holding investments

"Wholly or mainly" is not defined in the legislation; you need to consider the scale of investment activities on a case by case basis.

Ordinary property lettting is not treated as a business for IHT relief.

It is generally accepted that this test is not met where investment activities exceed 50% of turnover, but you have to weigh up the return on the various assets employed in the business, including human time. It may be that 99% of human activities and 99% of assets account for less than 50% of trading turnover, in which case the business would probably count as a trade, or it may not.

Tax tip: there is no mechanical test for BPR use the 50% rule with great care, and review cases year on year.