Entrepreneur’s relief: trading activity requirements and how best to reduce prospect of penalties

The recent case of Andrew Moffat v The Commissioners for HMRC concerned a claim for entrepreneurs’ relief (now business asset disposal relief – see below) and associated penalties. In this case, the taxpayers, Mr and Mrs Moffat, were denied entrepreneurs’ relief (in effect, a 50% Capital Gains Tax (CGT) reduction) on gains from selling shares in a company because the company wasn’t the holding company of a trading group. The company in question, Chelsea Marine Limited (“CML”), held (indirectly) all the shares in Chelsea Yacht and Boat Company Limited (“CYBCL”) which operated a pier (under a licence from Port of London Authority and a lease from the Royal Borough of Kensington and Chelsea) and provided moorings to boatowners in consideration of a licence premium and annual mooring fees, together with boat maintenance (and related) services as well as additional optional services including the provision of boat repairs and renovation.

The case significance

The amount of entrepreneurs’ relief in question totalled nearly £1.8 million (the claim preceded the reduction of the lifetime cap on the relief, now called business asset disposal relief, from £10 million to £1 million). The case centred on whether CYBCL was a trading company and, by extension, whether CML was the holding company of a trading group (a critical criterion for that relief to be available). Of additional and wider interest is how the Tribunal dealt with the appeal by the taxpayers against penalties totalling just over £370k for incorrectly completing their self-assessment tax returns by claiming the relief.

Claim for entrepreneurs’ relief

In support of the taxpayers’ argument that CYBCL was a trading company and that they were therefore entitled to entrepreneurs’ relief, Counsel argued that the extensive list of high-level maintenance and additional boat-related services, which enabled boatowners with limited knowledge and experience of nautical matters to live comfortably and safely in their boats, coupled with the amount of time invested by the 14 members of staff in providing these services pointed to CYBCL’s principal activity being trading activity. Further, CYBCL remained in occupation of the pier in much the same way as a hotel owner carrying on trading activity remains in occupation providing services to guests. In contrast, in the view of the taxpayers, CYBCL’s non-trading activity was, for these purposes, insubstantial.

The First-tier Tax Tribunal, however, sided with HMRC. The Tribunal noted that the main source of CYBCL’s income was from the licence premiums and mooring fees and that CYBCL’s income, therefore, derived principally from exploiting a proprietary interest in land. While substantial time was incurred by CYBCL’s staff on maintenance services, those services, being provided at cost, were not provided on a commercial basis with a view to the realisation of profits and so could not be categorised as trading activities. For tax purposes, therefore, CYBCL’s status was closer to that of a landlord investing in land than a hotel owner, with the boat maintenance charges akin to service charges under a lease, rather than charges for services that would typically be provided to hotel guests by the owner of the hotel business.

Appeal against penalties

HMRC also pursued the taxpayers for substantial penalties on the grounds that, in claiming entrepreneurs’ relief, they had been careless in the completion of their self-assessment tax returns, notwithstanding that they had sought advice, albeit orally, from two reputable firms of accountants to the effect that the disposal was eligible for the relief.

In finding that the taxpayers had not been careless in their completion of their tax returns (which included a description of the claim for entrepreneurs’ relief) and so allowing the appeal in respect of penalties, the Tribunal held that the relevant test to be applied is to consider what a reasonable taxpayer, exercising reasonable diligence in the completion and submission of the return, would have done. The Tribunal did not consider it unreasonable that the taxpayers had acted on the basis of advice obtained orally from professional and competent advisers (and thereby implicitly accepted the reasonableness of the taxpayers’ view that a formal written opinion from Counsel was not necessary). In addition, the Tribunal unequivocally rejected HMRC’s submission that the taxpayers had acted unreasonably in failing to contact HMRC to ascertain the correct tax treatment of the disposal of CML on 30 September 2016, stating:

“There is no obligation on taxpayers to contact HMRC to ascertain the correct tax treatment of a transaction or any potential claim for relief. Furthermore, HMRC are under no obligation or duty to provide such advice to taxpayers and we would expect any such request to HMRC for advice to be declined and the taxpayer advised to seek independent professional advice. We would be surprised if HMRC replied otherwise.”

Lessons from the case

An important lesson to draw from this case is that HMRC cannot generally be called upon to provided urgently needed “copper-bottomed” tax advice to sort out thorny tax issues (potentially involving aspects of corporate or property law) which taxpayers may have; indeed, doing so might even have unanticipated and unwelcome tax (and perhaps other) consequences for taxpayers.

The taxpayers in this case were perhaps lucky to succeed with their appeal of the penalties. A taxpayer wants to be able to show that they took reasonable care to win a penalty appeal on that basis. It is far better to be able to produce contemporaneous written records of advice received and followed. Indeed, a taxpayer who can do that will very likely avoid a penalty assessment being made by HMRC in the first place. Witness testimony of oral advice received some time ago is usually given much less evidential weight and carries a much greater risk of the Tribunal concluding that it does not know what advice was received and therefore cannot find that the taxpayer took reasonable care.

If you have questions or concerns about entrepreneurs’ relief, please contact tax lawyers Michael Fluss or Matheu Smith.