For a gain to qualify for entrepreneurs’ relief three factors need to be aligned: the use of the asset, the trading activity, and the timing of the disposal.
This alignment was missing in the case of the Patel Family v HMRC (TC04871), so their claims for entrepreneurs’ relief failed. Perhaps if they had done things in a slightly different order they may have succeeded.
Three members of the Patel family jointly owned a hotel in North London, which they ran as a partnership. In 2002 this business was incorporated, but the hotel remained in the personal names of the individuals, who also owned the shares in the company.
In 2006 the hotel was demolished and the company built seven flats on the site, which were sold over an 18 month period to January 2010. There was an agreement between the Patel family and the company about the redevelopment of the land, as the proceeds from those sales were split 50:50 between the individuals and the company. Each individual claimed entrepreneurs’ relief on their share of the gains from selling the flats in 2008/09 and 2009/10.
Business or business asset?
Entrepreneurs’ relief is only given if the taxpayer disposes of a business, a part of a business or a business asset. The tax tribunal quickly determined that the disposal of the flats didn’t amount to a disposal of a business carried on by the Patels, as any business relating to the flats was carried on by their company (if at all).
Were the flats relevant business assets? To meet this condition the flats must have been used for a trade undertaken by either the Patel partnership or by their company.
The tax tribunal judge found that individuals did not trade in their own names after their partnership business was incorporated in 2002, so this condition was failed. The flats could not have been used by the partnership as they didn’t come into being until after the partnership ceased trading.
The business assets must be disposed of within three years after cessation of the trade of the partnership or company, or be an associated disposal (see below). The trade in the partnership ceased in 2002 when it incorporated. The land the flats were built on was used by the partnership, but the sales of the flats in 2008 to 2010 were outside the three year post cessation period for the partnership.
The company ceased trading as a hotel in 2006, when the hotel building was demolished. The company then began a new activity of property development, but the new flats were not used as assets within the property development business. The Patel’s representative argued that the company intended to carry on a business using the flats, but it did not in fact do so. The flats were not let out by the company after construction. An intention to carry on a business has no effect for entrepreneurs’ relief.
If the Patels had proved that the development and post-development activities of the company were a trade, and the flats where used for that trade, it may have been possible to meet the conditions for an “associated disposal” of the flats, and thus qualify for the relief.
To be an associated disposal the flats would need to qualify as business assets, and be disposed of at around the same time as the individuals disposed of some shares in the company. Since 18 March 2015 at least 5% of company’s share capital must be disposed of by each shareholder, to make the associated asset disposal qualify for the relief. At the time of this case in 2008 to 2010, any number of the company’s shares could be disposed of to make the asset qualify as an associated disposal.
It’s essential to look at all aspects of a proposed business venture before a sale is made, as if all the relevant factors are not aligned, a claim for entrepreneurs’ relief will fail.