ETASSUM52105 - Enterprise Management Incentives (EMI): Qualifying companies: Excluded activities: Substantial part

Paragraphs 14 & 15, Schedule 5 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA)

Whether excluded activities amount in aggregate to ‘a substantial part’ of a trade is a matter of fact, to be decided in the light of all the relevant circumstances. No definition of the phrase is provided by the legislation. But where, judged by any measure which is reasonable in the circumstances of the case, such activities account for no more than 20 percent of the activities of the trade as a whole, HMRC will normally accept that they are not ‘substantial’.

To determine if a company will qualify requires identification of the trading and non-trading activities and then considering how best to measure the non-trading activities to see whether they are substantial in the context of the company’s activities as a whole.

There is no simple formula to do this but some, or all, of the measures or indicators below might be taken into account in reviewing a particular company’s status.

These indicators, adopted for Business Asset Disposal Relief, are the same as those used for the old taper relief and in the Substantial Shareholding Exemption for corporation tax and are relevant for EMI purposes due to ‘substantial part’ not being defined in ITEPA 2003 and taking its ordinary meaning of the word

Income from non-trading activities

For example, a company may have a trade but also let an investment property. If the company’s receipts from the letting are substantial in comparison to its combined trading and letting receipts then, on this measure in isolation, the company would probably not be a trading company.

The asset base of the company

If the value of a company’s non-trading assets is substantial in comparison with its total assets then again, on this measure, this could point towards it not being a trading company. If a company retains an asset, it previously used, but no longer uses, for the purposes of its trade, this may not be a trading activity (but see above regarding surplus trading premises). In some cases, it might be appropriate to take account of intangible assets (e.g. goodwill) that are not shown on a balance sheet in considering a company’s assets. Current market value and amounts given by way of consideration for assets may both be appropriate measures of the relative extents of a company’s trading and other activities. Which measure is appropriate will depend on the facts in each case.

Expenses incurred, or time spent, by officers and employees of the company in undertaking its activities

For example, if a substantial proportion of the expenses of a company were to be incurred on non-trading activities then, on this measure, the company would not be a trading company. Or a company may devote a substantial amount of its staff resources, by time or costs incurred, to non-trading activities.

The company’s history

For example, at a particular instant certain receipts may be substantial compared to total receipts but, if looked at on a longer timescale, for instance if a company’s trade was seasonal, they may not be substantial compared to other receipts over that longer period. Looked at in this context, therefore, a company might be able to show that it was a trading company over a period, even where that period may have included particular points in time when non-trade receipts amounted to a substantial proportion of total receipts.

Balance of indicators

The indicators discussed should not be regarded as individual tests to which a percentage limit applies. They are factors, or indicators, that may be useful in establishing whether there is substantial overall non-trading activity.

It is likely that some indicators point in one direction and others the opposite way. You should weigh up the relevance of each in the context of the individual company’s activities as a whole.

In most cases it should be clear if you are considering a trading company.

The First-tier Tribunal decision in Assem Allam [2020] TC07532, relating to entrepreneurs and business investment relief, provides an example of a case where there were substantial non-trading activities for the company and how the individual factors were considered. That decision was subsequently confirmed following an appeal to the Upper Tribunal, see the [2021] UKUT 0291 (TCC) decision. In the case the company had a substantial investment portfolio and the key question was whether or not this amounted to substantial non-trading activity. The UT stated:

“We do not accept that activities in this context are to be construed so narrowly. We accept that the reference to ‘activities’ in section 165A(3) Taxation of Chargable Gains 1992 is in the sense of what the company actually does must be looked at in commercial terms. In that sense, trading is an activity, but so too is holding an investment property and receiving rents. That is what the FTT meant when it described the activity of holding property and collecting rent as a ‘passive activity’. There may be little action required on the part of directors and employees in such an activity, but it remains an activity in commercial terms.”