Contractors, don’t expect BADR if your company has ceased trading

With IR35 reforms now well and truly embedded, those contractors who took the ‘wait and see’ approach as to what to do with their limited company may now find a nasty sting in the tail if they seek to close the company and claim Business Asset Disposal Relief (BADR), writes Leila Ghazzali, trainee solicitor at WTT Legal.

When you can (and can’t) get BADR

Despite being under threat of being scrapped for the past few years, BADR continues to be available for a disposal of the whole or part of a business, and for a disposal of the assets used for the purposes of a business that has now ceased. BADR is also available to directors and employees selling shares in the company (or group of companies) they work for.

Formerly known as Entrepreneurs’ Relief (ER), BADR is a valuable relief on gains under the Capital Gains Tax (CGT) regime, as it reduces the tax rate to 10%.

However, in order to take advantage of the relief, although the rules may seem straight forward, you may find that the relief has been claimed incorrectly as one of the requirements of BADR is that the company must be trading. The relief will not be available if, to a substantial extent, the activities of your company were non-trading (i.e. investment activities) or the company has ceased to trade.

The Allam case: in a nutshell

This key point was demonstrated in the recent case of Assem Allam v HMRC [2021] UKUT 291 (TCC). The facts of the case (put simply) are as follows:

• Dr Allam sold the entire shareholding of a company ADL to a trading company AML.
• ADL was in the business of property development and leasing properties.
• AML was a trading company and a wholly-owned subsidiary of Allamhouse, which was owned by Dr Allam and his wife.
• In 2011 ADL was sold to AML for £4.9 million and claimed BADR (which at the time was ER). HMRC opened an enquiry into the 2011/12 tax return on the basis that the company was not trading.

The First-Tier Tribunal (FTT) concluded that although it was accepted that ADL carried on trading activities in the form of development activities, it was found to be not entitled to the relief as, ‘to a substantial extent,’ the activities were non-trading. The FTT considered that the main source of income was rental income from its properties.

The Upper Tribunal (UT) subsequently agreed with the FTT and considered that it was necessary instead to look at the nature of the activities and to measure in some way the extent of those activities in the context of the company’s activities as a whole, as opposed to applying a numerical value/threshold to decide the ratio of trading activities versus non-trading. Interestingly, this slightly differentiates from HMRC’s guidance which interprets “substantial” as over 20%.

Unsuccessful arguments

The taxpayer argued that ‘activities’ were restricted to actual human activities, i.e. what the directors and employees actually did. The holding of investment property and collecting rent involved little activity therefore it was argued by Dr Allam that it should not be considered as activity and therefore could not be considered a non-trading activity.

The UT dismissed this and held that ‘activities’ meant what the company did in commercial terms, so that the holding of investments was an activity, thus ‘to a substantial extent,’ the activities were non-trading.

Are you a ‘trading company’?

As demonstrated in this case, the relief is restricted to trading companies (such that shares and securities in companies with substantial investment-related activities will not qualify for BADR), but also is not applicable if you have ceased to trade. And “trading company” is defined as a company which carries on trading activities and does not carry-on other activities to a substantial extent. Furthermore, if you are no longer trading and your company is dormant, this may mean that BADR may no longer be available, as well as other reliefs such as Business Property Relief for inheritance tax purpose. The trading requirement will be available if the company has ceased trading, provided the company has satisfied the trading conditions for one year ending on the day the company ceased trading; and ceased trading within three years ending on the date of disposal of its assets.

Finally fail to plan, plan to…

Therefore, if you are uncertain about your position you may want to consider your options, such as closing down your limited company by way of Members’ Voluntary Liquidation or Strike Off. However, in the uncertain covid-omicron climate, plus given the volatility of the contracting market, planning is extra important. In fact, with effective planning you can minimise tax liabilities and take advantage of any allowances, reliefs and exemptions. Crucially, remember your situation will be unique to you and so you should consider what your own individual options will look like -- make a plan that is aligned with your situation , ideally with the help of adviser, and make this plan whether you are expecting an outside IR35 role, temporary work, or full-time employment.