Tribunal confirms that trading had commenced for the purposes of Entrepreneur's Relief

In John Douglas Wardle v HMRC [2024] UKFTT 00543 (TC), the First-tier Tribunal (FTT) allowed the taxpayer's appeal and confirmed that a limited liability partnership had commenced trading, for the purposes of Entrepreneur's Relief (ER).

Background

John Douglas Wardle (the Appellant) had an interest in Biomass UK No. 1 LLP (the LLP), which undertook a project to construct a waste-to-energy power plant (the Plant) at the Port of Hull (the Hull Project). The Hull Project aimed to divert biomass waste from landfill and use it to produce electricity which would be exported into the wholesale market. The Appellant's involvement with the Hull Project began in early 2014 when, as part of a project team, he purchased the Hull Project and associated rights from a third party.

From 2014, various steps were undertaken toward the construction of the Plant. These steps included: 

• the preparation of a financial model to facilitate engagement with potential funders; 
• the issuing of a Project Information Memorandum to a number of potential funders followed by the entering into of exclusive Heads of Terms with the chosen funder for the financing of the Hull Project; 
• the engagement of a full team of legal, financial, tax, accounting, market, environmental and fuel advisers to carry out due diligence; 
• securing final approval to proceed from the funder’s Investment Committee; 
• the establishment of the LLP as the special purchase vehicle for the Hull Project; 
• entering into a connection agreement with the grid company to connect the LLP to the grid company’s distribution system;
• entering into a new partnership agreement that established a substantial organisational and management structure and mapped out how the LLP would proceed with the Hull Project;
• entering into an unsecured loan agreement with the funder;
• entering into approximately 56 contracts with various parties relating to the construction, operation and financing of the Plant on 21 August 2015 (Financial Close); 
• entering into a power purchase agreement (PPA) with the grid company relating to the sale of electricity; 
• drawing down funds under the loan; 
• entering into a 25 year lease of land in Hull; 
• securing relevant environmental permits; carrying out of commissioning tests and trial runs; and 
• optimisation, commissioning and construction of minor residual elements, such as landscaping. 

Electricity was generated commercially for the first time in June 2019.

In February 2020, the Appellant disposed of his remaining interest in the LLP and made a claim for ER (now Business Asset Disposal Relief) in relation to the disposal, in his self-assessment return for the tax year 2019/20. HMRC subsequently opened an enquiry into the return and determined that the LLP did not trade at the date of the disposal. HMRC therefore denied the Appellant’s claim to ER. The Appellant appealed to the FTT.

FTT decision

The appeal was allowed. 

The issue before the FTT was whether the disposal constituted a material disposal of business assets under section 169I(1), Taxation of Chargeable Gains Act 1992 (TCGA). The answer to that question ultimately turned on whether the LLP was trading for the period of two years ending with the date of the disposal in February 2020 (the Relevant Period). Accordingly, the central issue in the appeal was when, if at all, the LLP commenced trading. 

Applying the three-step test identified in Mansell v HMRC [2006] STC (SCD) 605, the FTT rejected HMRC's argument that the LLP had not commenced trade by Financial Close, or at any point prior to the disposal. The parties were agreed that step one of the Mansell test was satisfied, and that the LLP had a specific concept of the type of activity to be carried on, namely, generating profit from the construction and operation of the Plant. HMRC also accepted that, if step two of the Mansell test was satisfied, then step three would also be satisfied because the PPA was operational activity, being dealings with a third party that were immediately and directly related to the supplies to be made which it was hoped would give rise to expected profit and which involved the LLP putting money at risk. Accordingly, the key issue was whether step two of the Mansell test was satisfied, namely, that the LLP's trade had been "set up". 

The FTT determined that "set-up" did not require full, 100% completion. Rather, step two required the setting up of the business "to the extent it needs to be set up", which was a fact-sensitive analysis and what is required to set up one business to the requisite level will vary (potentially greatly) from what is required to set up another. Further, the FTT considered that, perhaps depending on the trade in question, set-up could coexist with operational activity in that there was not necessarily a bright line moving between the two, but that, in reality, the two could proceed hand-in-hand. 

Having weighed up all of the available evidence, the FTT determined that the second step in the Mansell test was satisfied for a number of reasons. Firstly, the partnership agreement organised the decision-making structure and management. Secondly, the finance was fully organised with funds being drawn down from 24 August 2015 and continually thereafter. Thirdly, Financial Close was reached and notices to proceed had been issued. In summary, the FTT concluded that "the train was on the tracks travelling to its destination" with a genuine and very substantial commercial underpinning and purpose, and it was being conducted under the integrated suite of agreements determining many aspects of its activity, including operational activities. The agreements were inter-related and had been drawn up to a high degree of complex legal, financial and technical detail. The FTT was therefore satisfied that the LLP traded in the Relevant Period and accordingly that the Appellant was entitled to ER.

Comment

Disputes with HMRC concerning the commencement of a trade are becoming increasingly common and affect large numbers of taxpayers. The innumerable number of different trades combined with the fact-sensitive nature of the legal analysis means that identifying the date of commencement of a trade can be difficult, which can create a significant amount of uncertainty for taxpayers. This is especially true for trades that require the construction of capital intensive trade-specific infrastructure with long lead-in times before sales take place and profits are generated, such as with the construction and operation of a power plant. 

This decision provides some helpful guidance on the approach to be taken when determining the commencement of a trade and confirms that a trade can commence despite not all of the underlying infrastructure being complete. 

HMRC has indicated that it intends to appeal this decision and, assuming it is given permission to appeal, it will be interesting to see what approach the Upper Tribunal takes to this very important issue. 

The decision can be viewed here.