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Enterprise investment scheme: excluded activities
Enterprise investment scheme: excluded activities
For the purposes of the enterprise investment scheme, the requirements which a trade must meet if it is to be a qualifying trade are set out at section 297, Taxes Act 1988. Section 297(2) provides that the trade must not consist of any of the various activities listed in that subsection, neither may such activities, taken together, form a substantial part of the whole trade. (These activities will be referred to below as excluded activities.) In order to decide whether a particular trade is a qualifying trade, it is therefore necessary to ascertain whether it includes any excluded activities.
This article focuses on the three types of excluded activity listed in section 297(2)(e): leasing, receiving royalties and receiving licence fees. The article applies equally for the purposes of the corporate venturing scheme, enterprise management incentives and the venture capital trust scheme, for which the corresponding rules are found in paragraphs 25 to 26 of Schedule 15 to the Finance Act 2000, paragraphs 18 to 19 of Schedule 14 to the Finance Act 2000 and paragraph 4 of Schedule 28B to the Taxes Act 1988, respectively.
Leasing
Leasing is defined in the statute as including letting ships on charter (though this exclusion is subject to an exception, which is set out in section 297(6), Taxes Act 1988) and letting other assets on hire. It thus covers any trading activity which consists in allowing the customer the use of the trader's property. Examples are television rental, video hire and the provision of self-storage warehousing facilities. It applies where, subject to reasonable conditions imposed by the trader, the customer is free to use the property for the purpose for which it is intended.
One area which has been found to give rise to difficulty is what is, and what is not, car hire. The question to be considered here is whether the person using the car is the company or the company's customer. On the one hand, the company may itself use the car to provide a transportation service for customers. On the other hand, the company may provide the car to the customer as a transportation facility, for use by the customer. The latter activity constitutes hire of an asset. A taxi service is likely to be a transportation service. By contrast, what is offered by a company providing chauffeured car hire is likely to be a transportation facility. The fact that the customer is not personally driving the car does not mean that that person is not the person using the car. But what is important is not the label 'taxi service' or 'chauffeured car hire', but the true nature of the contract between the parties.
Licence fees
Licences may be granted as a means of exploiting an interest in land. But in some situations the grant of the licence is merely incidental to an activity of supplying services. In such cases it is considered that section 297(2)(e), Taxes Act 1988 is not in point; for example, what the proprietor of a cinema offers in return for payment for a ticket is not just to admit the customer and provide a seat, but to show a film.
This principle can be illustrated by looking at activities concerned with the provision of sports and leisure facilities. At one extreme, a simple activity of making sports facilities available to the general public, with no provision of services, would consist of little more than charging a fee in return for the right to use property. This would be an activity of receiving licence fees. But such a situation would be exceptional. A more commonly encountered activity might be operating a health club which provides a high level of services, including active supervision and advice from qualified staff. Here the licence to enter the premises and use the equipment would be merely incidental.
In some cases where fees for admission are received, while there is no direct provision of services to customers, continuous work is required to keep the property in a fit state for use by them. The main question to be considered in any such case is the extent to which the fees relate to the cost of such work.
Double taxation relief
Dividends from groups taxed overseas as a single entity
Paragraph 15 of Schedule 30 to the Finance Act 2000 introduced a new section 803A, Taxes Act 1988. In some countries the law may provide that one company may pay tax in respect of the aggregated profits of itself and others as if they were a single entity. The new provisions at section 803A provide that, for the purposes of calculating credit relief, the relevant profits of these companies are regarded as a single aggregate figure in respect of a single company and the foreign tax paid by the responsible company was paid by that single company.
The consolidation rules of some countries provide that under certain circumstances foreign companies may be brought into the consolidated group for tax purposes. The section 803A provisions are framed so that only companies that are resident as a matter of fact in the country concerned may be included in the calculations of relevant profits and foreign tax for the deemed single entity. By the same token, a dual resident company will be included in the calculation of underlying tax on the group as a single entity if it satisfies the criteria for inclusion.
It is possible that a consolidated group may have no relevant profits at all, but be subject to foreign tax. If a company within the group pays a dividend to a United Kingdom company it is possible that it may be disadvantaged under the new rules, which came into play for dividends paid to the United Kingdom on or after 21 March 2000. Because the start date for other aspects of the Finance Act provisions were extended, the Revenue will accept that underlying tax may continue to be calculated using relevant profits for the individual companies in accordance with existing practice and information leaflets for dividends paid to the United Kingdom prior to 31 March 2001.
The following brings together various matters concerning the taxation of a group as a single entity.
In some countries it is possible to include branches in a consolidated group for tax purposes. Section 803A specifically states that the entities to be included must be resident in the country concerned. It does not therefore extend to branches of non-resident companies.
How precisely should consolidation be defined for the purposes of section 803A?
Section 803A applies where 'tax is payable by any one company …'. In the United States, for example, tax may be paid by any or several members in a single year, and not necessarily by the company which is the common parent. The legislation covers any type of consolidation that falls within the stated criteria.
The legislation does not extend to quasi-consolidations, where countries do not permit the filing of consolidated tax returns, even if they arrive at the same result by allowing the surrender of tax attributes among companies.
How should a consolidated group that includes a branch be split to exclude the relevant profits and tax in respect of the branch?
The starting point will be, as now, the accounts of the relevant companies. There will normally be separate accounts for the branch in existence, and these will be the primary indicators of the relevant profits and tax to be excluded from the single taxable entity under section 803A. If no separate branch accounts exist, the facts and circumstances, and the particular information available in that particular case, will be considered on a case by case basis to determine the profits arising for the branch, in the same way as happens now, for example for section 797 purposes.
What if a partnership or an entity that the United Kingdom does not recognise as coming within the definition of a company is included?
The pre-conditions of section 803A are satisfied for the companies, but the partnership is not, by definition, a company and so it cannot be included. As for a branch of a foreign company, the appropriate amounts of relevant profits and foreign tax will need to be excluded from the calculation of underlying tax for the section 803A entity.
What happens when there is one consolidated grouping for federal tax purposes, but state taxes are paid on an individual company basis?
Suppose corporations A, B and C are in a consolidated group for federal tax purposes and therefore within section 803A. A dividend paid by A is treated as paid by A/B/C out of the aggregate relevant profits of A/B/C and the foreign tax paid by A, B or C is paid by A/B/C. So if A also pays a state tax this will be included as part of the total foreign tax available for relief on an aggregate basis.
What if overlapping consolidations are permitted for different taxing jurisdictions within a country?
Consolidations involving different companies may be allowed for federal as opposed to, say, state taxes. In such a case it may be necessary to calculate the amount of, say federal tax, on a consolidated basis, but the state tax might relate only to that one company. It will be a question of fact in each case, and if necessary the different taxes claimed for relief will need to be considered separately.
How are relevant profits and underlying tax calculated when a further dividend is paid out of a source where a previous dividend had been specified?
The intention in these circumstances is that, as far as possible, underlying tax and relevant profits should neither be counted twice, nor fall out of account. This will be most easily achieved by taking the residue of profits and tax remaining in the company after any amounts which have been specified. If this does not give an equitable result in any particular case, the full facts and circumstances should be discussed in the first instance with the underlying tax group.
What happens on acquisitions and disposals?
If a new company is brought into the consolidated group it may bring accumulated profits with it. If the new parent can access these accumulated profits and pay a dividend out of them, then they should be included in the aggregate figure of relevant profits for the consolidated group. The converse will apply when a company leaves the group.
What if there are accumulated losses?
Pre-acquisition losses will be dealt with on a consistent basis. Where a group acquires a new member with accumulated profits that can be accessed to pay dividends, the Revenue will take into account the pre-acquisition profits and losses that have produced the accumulated profits, and the associated foreign tax paid. Where a group acquires a new member with an accumulated deficit, the pre-acquisition profits and losses that have produced the deficit will also be taken into account in arriving at relevant profits, together with any foreign tax paid.
What paperwork is needed to support such a specification?
Dividend specifications normally arise in dividend resolutions, which would not exist for a notional single company. The Revenue will accept a board resolution of the company declaring the dividend. This should minute that, for the purposes of United Kingdom double taxation relief, the dividend is deemed to be out of the relevant accounting period of the single company.
Can United States generally accepted accounting practices accounts be used?
If United States generally accepted accounting practices accounts are produced for a consolidated group they will be accepted by the underlying tax group as a basis for determining relevant profits provided that this is done on a consistent basis.
The foregoing are extracts from longer articles published in the Tax Bulletin which is Crown copyright, and to which reference should be made for details of the full text. For information regarding subscription, contact Ms Nahid Shariff on 020 7438 7842. It is also available free of charge at www.inlandrevenue.gov.uk.
