Substantial: What is it?

By | 30 November 2021

Business asset disposal relief (BADR) offers a capital gains tax (CGT) rate of 10% on net chargeable gains of up to £1 million (for 2022/23). A claim for BADR is available on a material disposal of business assets, such as an individual’s company shares, where certain conditions are satisfied.

Trading company?

For an individual shareholder disposing of shares in a company, one of the common conditions for relief is that throughout a two-year period ending with the date of disposal, the company is a trading company (or the holding company of a trading group) (TCGA 1992, s 169I(6)).

A ‘trading company’ for BADR purposes is defined as a company carrying on trading activities whose activities do not include non-trading activities to a substantial extent. ‘Substantial’ is widely accepted to mean more than 20% of certain measures, which can include income from non-trading activities, the asset base of the company and/or expenses incurred or time spent by officers and employees of the company in undertaking its activities (see HMRC’s Capital Gains manual at CG64090).

Many companies own non-trading assets. For example, rental income from investment properties may account for less than 20% of the company’s combined trading and letting receipts, but the value of those properties may be ‘substantial’ in comparison with its total assets. This can cause uncertainty about trading status.

20% test…or is it?

However, in Allam v Revenue and Customs, the First-tier Tribunal ([2020] UKFTT 216 (TC)) interpreted ‘substantial’ as follows:

“The legislation itself does not elaborate further on the meaning of the phrase ‘to a substantial extent’. We must apply those words giving them their ordinary and natural meaning in their statutory context….in our view, “substantial” should be taken to mean of material or real importance in the context of the activities of the company as a whole” (emphasis added).   

Subsequently, the Upper Tribunal ([2021] UKUT 291 (TCC) upheld the First-tier Tribunal’s decision, commenting:

“We accept that the reference to “activities” in s 165A(3) is in the sense of what the company actually does, but the question of what the company actually does must be looked at in commercial terms. In that sense, trading is an activity, but so too is holding an investment property and receiving rents.”

In Potter v Revenue and Customs [2019] UKFTT 554 (TC), the taxpayers (Mr and Mrs P) were the director shareholders of a company (G), which until 2009 traded on the London Metal Exchange and brokered credit deals. The business was successful and had built up reserves of over £1 million when the financial crash occurred in 2008/09. To safeguard its reserves, G used approximately £800,000 of those reserves to purchase two six-year investment bonds, which matured in November 2015. The capital was locked up during that period, but the bonds paid interest of £35,000 a year.

As a result of the financial crash, the volume of trades declined dramatically. The last invoice issued by G was in March 2009. The company was put into voluntary liquidation in the tax year 2015/16. One of the issues was whether G was disqualified as a trading company for BADR purposes (or entrepreneurs’ relief, as it was then called) because its activities included investment activities to a ‘substantial’ extent. The tribunal noted that once the company had put its money into the bonds it did not (and could not) do anything else in relation to them for six years until they matured. There were no investment activities; thus, G’s activities did not, to a substantial extent, include non-trading activities.

However, the Upper Tribunal in Allam pointed out that the First-tier Tribunal’s decision in Potter was not authoritative, and added:

“[The tribunal] does seem to have placed considerable weight on the absence of any physical activity in relation to the investment bond. Indeed, it seems to have viewed that as not involving any activity at all. We do not consider that the FTT was right in that regard. There would always be some activity involved in such an investment, even if it is only checking that the interest is paid each year.”

Practical point

‘Do the numbers’ to check that the 20% threshold for non-trading activities is not breached for BADR purposes. But first, consider whether there are non-trading ‘activities’ at all.

The above article is based on an article first published by Tax Insider (April 2021) (