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Entrepreneurs Relief has the ability to halve the tax payable on the sale of a business, including shares in a trading company, reducing the tax rate from 20% to just 10% on up to £10 million of gains.

In order for the sale of shares to qualify for Entrepreneurs Relief, among other things, the company must be primarily a trading company. The general rule is that if the company has more than 20% non-trading activities it will fail the test and the relief will be denied. However the question is 20% of what?

The First Tier Tribunal grappled with this question in the case of Potter [2019]UKFTT554

Mr & Mrs Potter held shares in a company called Gatebright Ltd. It was undoubtedly a trading company but it relied heavily on being able to raise finance for its deals. After the last financial crash, try as they may, they were unable to raise the finance they needed and they closed the company in 2015. They had not raised a single sales invoice for several years.

They claimed Entrepreneur's Relief on the distribution in liquidation of the company and HMRC denied it on the grounds that the company had not been trading in the 12 months prior to ceasing.

The company had accumulated significant reserves which it would normally need to put towards the finance of trades it did. It was a dealer in metals on the London Metals Exchange. Its reserves sat in an investment bond until it was ready to make the next trade, which didnít happen.

On the face of it the company had no sales in the twelve months prior to ceasing and the main asset was an investment bond. You can have some sympathy for HMRC thinking that this did not qualify. However the test is of the company's activities and in the case Mr & Mrs Potter were diligently trying to put the next trade together, albeit unsuccessfully. The Tribunal were satisfied that whilst the company did not actually trade in the 12 months prior to ceasing, it was preparing to trade by seeking to raise the wherewithal. The fact that the trade was unsuccessful was not a concern.

Whilst these cases all turn on their own particular facts it does give hope for those companies which have built up reserves in passive investments.

Andrew Law is an author for accountingcpd. To see his courses, click here.

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