Entrepreneur's relief, non-trading assets
Discussion
I understand the guideline to qualify as a trading company is to have less than 20% of your Balance sheet being made up of non-trading assets, less than 20% of your turnover (not profit?!)from NTA's and less than 20% of your management time being spent on NTAs.
I've scoured the net to try and find out what would happen if the company borrows against these assets and then employs the funds in qualifying trading activities; would the value of the "net equity" be used in assessing the value of NTA's, or would the whole value apply?
ie)
if the company has a Balance sheet of 100,000 - of which 50,000 was a non-trading investment, and the remaining 50,000 was employed in the trading business. This I presume would fall foul of ER criteria, as the NTA was more than 20% of the balance sheet.
if however the company borrowed 35,000 against the NTA, leaving 15,000 (or 15% of the BS) equity remaining in the asset, and subsequently employs these funds in the trade of the company, would this then be OK?
I've scoured the net to try and find out what would happen if the company borrows against these assets and then employs the funds in qualifying trading activities; would the value of the "net equity" be used in assessing the value of NTA's, or would the whole value apply?
ie)
if the company has a Balance sheet of 100,000 - of which 50,000 was a non-trading investment, and the remaining 50,000 was employed in the trading business. This I presume would fall foul of ER criteria, as the NTA was more than 20% of the balance sheet.
if however the company borrowed 35,000 against the NTA, leaving 15,000 (or 15% of the BS) equity remaining in the asset, and subsequently employs these funds in the trade of the company, would this then be OK?
As is often the case, lay people often assume that if they jump through specific hoops they will magically ensure that they meet whatever criteria is required to match some desired tax outcome.
UK tax doesn't always work like that. An awful lot of it is deliberately left a bit vague so that the tax authorities can interpret the circumstances. In some ways, this leaves people unsure of where they stand. On the other hand, it does mean that the law can be viewed as a set of rules designed to facilitate genuine cases rather than allow artificial constructs to satisfy a narrow set of criteria.
UK tax doesn't always work like that. An awful lot of it is deliberately left a bit vague so that the tax authorities can interpret the circumstances. In some ways, this leaves people unsure of where they stand. On the other hand, it does mean that the law can be viewed as a set of rules designed to facilitate genuine cases rather than allow artificial constructs to satisfy a narrow set of criteria.
Alpinestars said:
It's a gross asset test. You should also note it is not a statutory test. It's HMRC's interpretation of what substantial means. It's also not prescriptive. You should take all factors into account when assessing whether a company is trading or not.
ok, so based on the above example, if the asset was mortgaged, gross assets would increase to 135,000, and the proportion of NTA's to gross assets would decrease from 50% to 37%? I understand that it's all up for interpretation, but from my past experience with HMRC, it's better to minimise any grey areas!
As stated above, the general position is gross assets.
In your original example, you said gross "good" assets 50, gross "bad" assets 50. And borrowings (against the "bad" assets of 35. Therefore I don't get your last post saying gross assets are 135. They are 100.
HMRC's position is likely to be:
Good assets 50
Bad assets 50
% of gross assets that are bad is 50%, therefore not trading on the basis of this test.
However, HMRC will generally accept that if you pass the other two tests (management time and income), failing the asset test is not terminal.
In your original example, you said gross "good" assets 50, gross "bad" assets 50. And borrowings (against the "bad" assets of 35. Therefore I don't get your last post saying gross assets are 135. They are 100.
HMRC's position is likely to be:
Good assets 50
Bad assets 50
% of gross assets that are bad is 50%, therefore not trading on the basis of this test.
However, HMRC will generally accept that if you pass the other two tests (management time and income), failing the asset test is not terminal.
Alpinestars said:
As stated above, the general position is gross assets.
In your original example, you said gross "good" assets 50, gross "bad" assets 50. And borrowings (against the "bad" assets of 35. Therefore I don't get your last post saying gross assets are 135. They are 100.
HMRC's position is likely to be:
Good assets 50
Bad assets 50
% of gross assets that are bad is 50%, therefore not trading on the basis of this test.
However, HMRC will generally accept that if you pass the other two tests (management time and income), failing the asset test is not terminal.
I got the 135,000 from taking the existing gross assets (100k), and adding the 35k raised from the mortgage as additional assets, as the funds would be employed in the trade. Net assets wouldn't change, as the increase in gross assets would be offset by the borrowing. Is that not what you meant?In your original example, you said gross "good" assets 50, gross "bad" assets 50. And borrowings (against the "bad" assets of 35. Therefore I don't get your last post saying gross assets are 135. They are 100.
HMRC's position is likely to be:
Good assets 50
Bad assets 50
% of gross assets that are bad is 50%, therefore not trading on the basis of this test.
However, HMRC will generally accept that if you pass the other two tests (management time and income), failing the asset test is not terminal.
Also, interesting if HMRC may still allow it if only the asset test is failed. Is it the income / profit from the NTA as a proportion of total profit / income that they look at, or it is total revenue of the NTA versus total turnover that they look at?
Ah, window dressing. It's possible to "boost" your good asset base by borrowing so long as the funds are used for business purposes. However, even if you managed to demonstrate this, a company needs to be a qualifying company for the whole of the 12 months prior to the relevant disposal. So at best, your average assets would be used (50/117.5 being the "bad" proportion).
Re income, again it's a gross test and an income, not profit test.
One potential option is goodwill which relates to the trade and which is not recognised on the balance sheet. If you have such goodwill, that might help your asset test.
What does the company do and what is the non trading business?
Re income, again it's a gross test and an income, not profit test.
One potential option is goodwill which relates to the trade and which is not recognised on the balance sheet. If you have such goodwill, that might help your asset test.
What does the company do and what is the non trading business?
it's involved in cross-trading bulk raw materials - I also used to fund / buy stock for a specialist garage some years ago. As part of this relationship, I ended up with their freehold.
I've picked up a few more commercial properties over the years (all bought from retained trading profits), that either I consider have some development potential, or that I have rented to other family members. I have an o'd facility from the bank, secured against property, which I use in the trade as needed. On average though (over the course of the year), I'm probably only running gearing of about 10% of the balance sheet, with a max at anytime of about 30%.
I could gear more, to boost the gross assets, but to do this I'd need to take on riskier turnover, or start new trading activities, but I can't see that I could get below 20% of gross assets without off-loading the NTA's. My normal trading is fairly risky, so I'm loathe to sell-off the safer assets on the balance sheet, and increase my exposure in trading, just so I don't fall foul of ER/BRP.
I've picked up a few more commercial properties over the years (all bought from retained trading profits), that either I consider have some development potential, or that I have rented to other family members. I have an o'd facility from the bank, secured against property, which I use in the trade as needed. On average though (over the course of the year), I'm probably only running gearing of about 10% of the balance sheet, with a max at anytime of about 30%.
I could gear more, to boost the gross assets, but to do this I'd need to take on riskier turnover, or start new trading activities, but I can't see that I could get below 20% of gross assets without off-loading the NTA's. My normal trading is fairly risky, so I'm loathe to sell-off the safer assets on the balance sheet, and increase my exposure in trading, just so I don't fall foul of ER/BRP.
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