The incorporation of a business will often involve the disposal by a sole trader or partnership to a company of chargeable assets for CGT purposes, such as free goodwill or land and buildings. The disposal will normally be treated as taking place at market value for CGT purposes, on the basis that the parties are connected persons (TCGA 1992, s 18). However, there is a statutory relief for business incorporations under TCGA 1992, s 162, where certain conditions are satisfied. The effect of this incorporation relief is broadly that any CGT charge on the whole or part of the gains is postponed, until the person transferring the business disposes of the shares (i.e. there is an effective ‘rollover’ of gains on disposal of the assets, against the cost of the shares).
Incorporation relief under section 162 (‘Roll-over relief on transfer of business’) broadly requires that the business owner transfers to a company a business as a going concern, together with the whole assets of the business, or the whole assets other than cash, and that the business is transferred wholly or partly in exchange for shares in the company.
What is a 'business'?
One of the potential difficulties with incorporation relief is in determining what constitutes a ‘business’. The problem is that there is no statutory definition of ‘business’ for CGT (or income tax) purposes. The lack of a statutory definition has resulted in a First-tier Tribunal case, Ramsay v Revenue and Customs  UKFTT 176 (TC). In that case, the taxpayer was the landlord of a large property which had been converted into ten flats, of which five flats were occupied by tenants. The taxpayer and her husband transferred the property to a company, in exchange for shares in the company. Mrs Ramsay's tax return for the year of transfer included a claim for incorporation relief under TCGA 1992, s 162. Following an enquiry by HMRC into the return, HMRC issued a closure notice on the basis that section 162 relief did not apply. Mrs Ramsay appealed to the tribunal.
The tribunal considered whether the taxpayer’s activities in connection with the letting and administration of the property constituted the passive receipt of rent (i.e. an investment activity), or whether those activities were sufficient to constitute a business, thereby qualifying for section 162 relief.
Because there is no statutory definition of ‘business’ for CGT purposes, the tribunal looked at previous case law for help on what constitutes a business. Perhaps the most well-known and often quoted of those cases is American Leaf Blending Co. Sdn Bhd vs Director General of Inland Revenue  3 All ER 1185. The tribunal quoted from American Leaf Blending, and it is worth noting that more or less the same extracts from that case are included in HMRC’s Capital Gains Manual at CG65715, which discusses the meaning of ‘business’ for section 162 relief purposes. However, that case and the other tax cases mentioned by the tribunal dealt with different legislation, including national insurance and inheritance tax. The Ramsay case appears to be the first to deal with incorporation relief and property lettings.
Mrs Ramsay told the tribunal that she and her husband spent approximately 20 hours per week carrying out various activities, which it was claimed amounted to a business. Those activities were broadly as follows:
(1) Arranging to meet each tenant to explain that the rent must be paid on time, and also the accountant (who then was responsible for dividing the income);
(2) Checking and payment of quarterly electricity bills for the communal areas;
(3) Cancelling previous insurance policies and arranging a new policy;
(4) Attending the property to unblock the drains;
(5) Oiling and re-attaching steel wires on some of the garage doors belonging to the flats, and clearing debris in other garages;
(6) Returning post for previous tenants to the various senders;
(7) Confirming with the Council compliance with fire regulations, and installing/replacing fire extinguishers, where applicable;
(8) Erecting a post and wire fence and hedging;
(9) Creating a flower bed;
(10) Pruning the shrubs around the property, sweeping up leaves and discarding in the local refuse tip;
(11) Weeding the back garden and car park on a regular basis;
(12) Bleaching the flagstones to the rear of the building to remove algae;
(13) Vacuuming and dusting the communal areas on a regular basis and polishing the mahogany staircase;
(14) Frequently checking the security of the windows and doors;
(15) Upon finding rubbish dumped in the building car park, taking it to the Council tip;
(16) Cleaning vacated flats and clearing furniture in preparation for new tenants;
(17) Providing additional assistance in particular to one elderly tenant (e.g. dealing with telephone calls regarding alleged faulty electricity supply, replacement of a broken window and even liaising with social services in relation to her care package).
The tribunal looked at the National Insurance case Rashid v Garcia  SpC 348, and noted that the facts in that case were not dissimilar to Mrs Ramsay's case. In Rashid v Garcia, the taxpayer, either directly or through his family, spent between 16 and 24 hours per week in connection with the letting of four properties, which were let to both residential and commercial tenants. The weekly time was spent on activities such as dealing with the central heating, hot water, furniture, and alarms. It also included advertising for new tenants, carrying out credit checks on prospective tenants, drawing up tenancy agreements and collecting rent, in addition to cleaning common parts of the properties, maintaining the garden and carrying out annual checks on gas and electrical equipment. The Special Commissioner in Rashid v Garcia concluded that there was insufficient activity in respect of the properties for it to constitute a business. The taxpayer’s appeal was therefore dismissed.
The tribunal in Ramsay also looked at an inheritance tax business property relief case, Martin and another (executors of Moore deceased) v Inland Revenue Commissioners  SpC 2, where the deceased had carried on a business of owning and letting industrial units. It was held in that case that the activities carried on in respect of the property were part and parcel of a business of making or holding investments, so a claim for business property relief failed.
The tribunal held that the activities carried out by Mrs Ramsay were normal and incidental to the owning of an investment property, and arose out of necessity when owning a property let out as flats. The tribunal also noted that Mrs Ramsay had declared the property income under what was then Schedule A, and that at no time was it suggested that a Schedule D trade or business was being carried on. The tribunal dismissed Mrs Ramsay's appeal.
On the face of it, the decision in Ramsay seems rather harsh on the basis that there were ten flats in total. In Rashid v Garcia, four properties were involved, and although the Special Commissioner decided against Mr Rashid, he described the case as being “near the borderline”. However, the tribunal in Ramsay said that what had been transferred to the company was basically a large former residence which had been converted into the ten flats. It would be interesting to know whether the decision would have been different if the ten flats had all been in different locations.
The amount of time spent in the business is likely to be relevant in terms of establishing that there is a proper business being carried on as a going concern, as distinct from holding an investment passively. As mentioned, Mr and Mrs Ramsay spent around 20 hours per week working in the business, and in Rashid v Garcia the taxpayer and his family spent 16 to 24 hours per week in the business. However, what appears to be even more important is how that time is actually spent. It seems that activities need to be performed over and above those activities which are incidental to owning an investment property (e.g. maintenance). For example, if a cleaning service was genuinely offered and perhaps even a laundry service, it will probably be easier to argue that business was being carried on over and above mere investment activities.
For those looking for certainty about whether incorporation relief will be available on a transfer of rental properties to a company, it may be worth considering an application to HMRC in advance under the non-statutory business clearance service. It is possible to ask for clearance about legislation which is older than the last four finance acts, where there is material uncertainty about the tax outcome of a real issue of commercial significance to the business. The downside, of course, is that there is no right of appeal against rulings by HMRC, so one could finish up being stuck with a ruling that incorporation relief is not due.
However, it is ultimately a question of fact whether a business is being carried on, and no two cases are the same. The Special Commissioner in Rashid v Garcia adopted the approach of standing back and looking at all the facts and evidence. That seems like a sensible approach to adopt in all cases. So if the overall impression is that a business is being carried on as a going concern, that impression will hopefully be the right one.
Mark McLaughlin CTA (Fellow) ATT TEP