Mark McLaughlin looks at the distinction between partnerships and companies for business asset disposal relief (BADR) purposes in relation to pre-trading activities and capital gains tax, focusing on Wardle v Revenue and Customs.
The business asset disposal relief (BADR) provisions are relatively well known among tax advisers. BADR is very popular with individual clients, offering a capital gains tax rate of only 10% on a lifetime limit of chargeable gains from qualifying business disposals of up to £1m.
Despite its relative familiarity, disputes between taxpayers and HMRC still arise from time to time on the availability of BADR in certain circumstances. For example, a recent First-tier Tribunal (FTT) case considered whether the disposal of assets by a partnership that had not commenced trading represented disposals of a business eligible for entrepreneurs’ relief (ER) (prior to the relief being renamed BADR), and particularly whether pre-trading activities constituted ‘trading activities’ for relief purposes – more on this later.
BADR applies to ‘qualifying business disposals’, including a material disposal of business assets, such as the disposal of business assets by an individual (s169H, Taxation of Chargeable Gains Act 1992 (TCGA 1992); all statutory references are to TCGA 1992).
A ‘disposal of business assets’ includes a disposal of the whole or part of a business, or shares in a company (s169I(2)). A ‘business’ for these purposes is broadly a trade (or profession or vocation) that is conducted on a commercial basis and with a view to the realisation of profits (s169S(1)).
Partnerships versus companies
There are specific BADR provisions for individuals in partnership (s169I(8)):
- an individual’s disposal of (or of interests in) assets used for a business carried on by them on entering into a partnership, which is to carry on the business, is treated as the disposal of part of the business;
- a disposal by the individual of the whole or part of the individual’s interest in the assets of a partnership is treated as a disposal by that individual of the whole or part of the partnership’s business; and
- a partnership business is treated as owned by each individual who is then a member of the partnership.
By contrast, in the case of company shares, there is a material disposal for BADR purposes if one of several alternative conditions (A to D in the legislation) are satisfied. The most common condition (A) requires ‘personal company’, ‘trading company’ (or ‘trading group’) and officer or employee tests to be met throughout a two-year period ending with the date of disposal (s169I(6)).
A ‘trading company’ for these purposes is defined (in s165A) as a company carrying on trading activities that do not include non-trading activities to a substantial extent. ‘Trading activities’ include (among others) activities carried on by a company for the purposes of a trade it is preparing to carry on.
HMRC considers that activities for the purposes of a trade that a company (or group) is preparing to carry on might include developing a business plan for carrying on the trade, acquiring premises, hiring staff, ordering materials and incurring pre-trading expenditure for the purposes of the trade to be carried on (see HMRC’s Capital Gains Manual at CG64065).
Preparing to carry on a trade
It should be noted that ‘trading activities’ is defined in the context of a company, not a partnership. In the absence of an explicit reference to a partnership’s pre-trading activities, could the legislation be interpreted as treating companies and partnerships in the same way in this context? Unfortunately, a recent case indicates not.
In Wardle v Revenue and Customs [2021] UKFTT 124 (TC), the taxpayer was one of three partners who, in January 2014, established a general partnership under English law to develop, construct and operate renewable power plants at three locations in the UK. The partnership commenced pre-trading activities on 1 May 2014. When the projects reached the stage where construction could begin, the partnership sold two plants to a third party, in August and November 2015 respectively. The partnership had not commenced trading at that point. The taxpayer claimed ER on his share of the disposal proceeds in his self assessment return for the tax year 2015/16. Following an enquiry, HMRC denied the ER claim and the taxpayer appealed.
The FTT had to decide whether the disposal by a partnership of some or all of its business prior to the business having commenced trading nevertheless entitled the partners to claim ER on the capital gains on such a disposal, assuming all other conditions were met. The FTT considered that the ‘natural and ordinary’ meaning of the definition of a ‘business’ (in s169S(1)) required that an individual or partnership was disposing of something (or anything) that was at that time a trade. The trade must exist at that time; it did not extend to activities capable of being conducted as a trade at some future point.
The FTT found “striking” the difference in ER treatment between a partnership and a company in terms of pre-trading activities. There was no reason within the ER legislation why an interpretation must be adopted to ensure parity. The FTT concluded that the words chosen by Parliament (in s169S(1), TCGA 1992) required that a disposal by a partnership only constituted a disposal of the whole or part of a business if the partnership had commenced trading. Therefore, the disposals by the partnership were not a material disposal of business assets and did not qualify for ER.
Deliberate distinction
HMRC’s approach in Wardle underlines its view that pre-trading activities can only be taken into account for companies. Of course, FTT decisions do not carry the force of law. However, while the taxpayer in Wardle could appeal, it seems unlikely (to me, at least) that the FTT’s decision would be overturned.
Interestingly, the FTT in Wardle addressed the definition of a partnership’s business under the law relating to general partnerships (established under the Partnerships Act 1890 (PA 1890)), limited partnerships (established under the Limited Partnerships Act 1907) and limited liability partnerships (LLPs) (established under the Limited Liability Partnerships Act 2000 (LLPA 2000)) (the FTT referring to the legislation collectively as the ‘Partnership Acts’).
For example, a ‘partnership’ is defined (by s1(1), PA 1890) as “the relation which subsists between persons carrying on a business in common with a view of profit”. Furthermore, the incorporation of an LLP requires “two or more persons carrying on a lawful business with a view to profit” to subscribe their names to an incorporation document (s2(1), LLPA 2000).
Unfortunately for the taxpayer in Wardle, the FTT found that the rules and meaning of ‘business’ under the Partnership Acts were materially different to the definition of ‘business’ for ER purposes. The ER definition included the conditions ‘is a trade’ and ‘is conducted’. The FTT considered that Parliament chose these expressions deliberately.
Looking ahead
Company shareholders have an apparent advantage over business partners in respect of pre-trading activities for BADR purposes.
The message from Wardle seems to be that individuals who are contemplating the start of a new business should therefore consider operating it as a company, and undertake preparatory activities prior to the commencement of trading through that corporate vehicle, if such activities are likely to be a factor in the availability of BADR (eg, in terms of whether the two-year trading requirement (in s169I(6)(a)) is satisfied on a future disposal of the individual’s shares).
About the author
Mark McLaughlin, CTA (Fellow), ATT (Fellow), TEP, is a consultant editor to Bloomsbury Professional and a freelance tax writer