Potter case and non-trading activities for Entrepreneurs’ Relief purposes

The issue

A key requirement for Entrepreneurs’ Relief (ER) to be available in respect of a share disposal is that the company is a trading company or a holding company of a trading group. In order to meet the trading company requirement a company’s activities must not include non-trading activities to a significant extent. Although ‘significant’ is not defined in the legislation this is traditionally taken to be 20% and this figure is included in HMRC guidance. When this legislation came out everyone got very excited about company balance sheets which included investments and profit and loss accounts which included a large percentage of interest income. It was assumed that these kinds of things could jeopardise the ER position. As time has gone on commentators (and indeed HMRC) have focussed more on the word ‘activities’. The emphasis for ER has been on the question of what a company actually does rather than on what it has or earns.

The recent case of Jacqueline Potter and Neil Potter and HMRC has provided a welcome recap on these issues.

The Potter case

This case involved a company which provided brokering services to clients who wanted to trade in precious metals and other commodities. Its business model worked by sharing a commission with banks to which it referred lenders. The business was essentially decimated by the 2008/2009 credit crunch and its final invoice was issued in 2009. However the company and its directors did endeavour to revive its business by meeting with various contacts. Before the collapse in trade the company had used its reserves to invest in £800,000 of investment bonds. These were 6 year bonds with an annual interest yield of £35,000. Despite the fact that after 2009 the majority of the company’s assets comprised the investment bond and its sole income was the £35,000 interest, The Upper Tribunal ruled that the company did not have significant non-trading activities. This was mainly to do with the fact that almost no activities related to the bonds and that the company was trying (albeit unsuccessfully) to revive its trade.

Forbes Dawson view

This is a particularly powerful case because not only does it re-emphasise the importance of activities but it also clarifies that a company can be trading even if it is not making any trading income. In this case the company was trying to rejuvenate its trade in the face of an adverse economic climate and this was enough to maintain the company’s status as a trading company.

This also reminds us that to the extent a trading company does want to engage in an ‘active’ investment activity then it should consider lending funds earmarked for investment to a separate investment company to allow it to undertake the investments. On the principles of the Potter case the debtor balance in respect of the investment company should not jeopardise the trading company’s ER status (although of course the investment company itself will not be a trading company if it is disposed of or liquidated in the future).

 

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