Diversifying Businesses

How entrepreneurs can protect CGT and IHT reliefs

The personal and the business interests of an entrepreneur are, to a large extent, one and the same thing. As advisors, we know that it is impossible to deal with the personal affairs of an entrepreneur in isolation, since the business interests inevitably affect the tax affairs of the person. In this article we consider what steps can be taken to stop valuable reliefs being lost when entrepreneurial businesses grow and diversify. Whilst the benefit of our advice is ultimately felt by the individual, the strategy we develop draws on the expertise of the wider Deloitte team beyond Private Client Services, including Corporate Tax, Indirect Tax, Reorganisation Services, the Stamp Duty Team and Assurance & Advisory. Growth and diversification

In the early days of an entrepreneurial business, the activities are usually clearly defined and the focus is on growing the business. As time passes and the business (and also the entrepreneur) becomes more successful, there is often a temptation (and sometimes a valid business reason) to diversify, with the result that the original activity becomes a less significant part of the business.

Where the business is initially involved in a trading activity, it is not uncommon for the diversification to take the form of investment, with surplus cash being invested in any number of assets, including property, or simply retained as cash. For tax purposes, these investment activities are very different from the original trading activity, although the individual will usually regard them as still being part of the same business. The distinction between trading and investment activities is not always clear, and often the first stage is to assess whether there is an issue, or likely to be one in the future.

The bottom line

Having taken some advice in the formative years of the business, an entrepreneur may look forward to selling the business with an assumed 10% capital gains tax (CGT), or to making gifts of shares without any inheritance tax (IHT) implications. Unfortunately, the often slow swing from a trading company towards an investment company can bring disastrous consequences for tax purposes.
The main reliefs affected by this type of change in the activities of a company are:-


The test for CGT is whether the business has “significant non-trading activities” (more than 20%), whereas the IHT test is whether the business is “mainly” trading (more than 50%). Any strategy will therefore depend very much on whether the company is to be sold or retained. Ultimately the loss of these reliefs affects the bottom line of the individual, regardless of whether they are personal or business reliefs.

Separation is the answer

One option is to undertake a formal demerger of the two types of activity, however this can only be done where certain conditions are fulfilled. Where they are not, as in the above scenario, an alternative reconstruction method can be used to split out the investment element of the business from the ongoing trading element. In this way, the valuable reliefs can continue to accrue for the trading part of the business. The method employed is a liquidation of the company (or holding company of a group structure) under the Insolvency Act 1986. The assets of the company are then distributed as a capital distribution on liquidation. However, rather than being passed to the shareholders, the assets are transferred to new companies in exchange for an issue of shares to the original shareholders. Providing appropriate clearances are obtained and various other conditions are fulfilled, there are no immediate tax consequences of the reorganisation. The historic periods of ownership are preserved for both the trading and investment parts of the business (now separated). However, going forward, the business asset status of the former is untainted by the non-business asset status of the latter. For CGT purposes there may still be an historic nonbusiness period prior to the separation to be taken into account, but for IHT purposes the benefit is immediate. Other reasons for separation

This method can also be used for reasons other than the loss of tax reliefs, although each can impact on the bottom line for the entrepreneur:

Practical solutions

Ultimately, the bottom line is what matters most, and ensuring that valuable tax reliefs are preserved is key to keeping this as healthy as possible. If you would like to discuss any of the issues raised above further, please speak to your usual Private Client Services contact.