Excluded activities: Tax Bulletin 54: EIS - qualifying trades
Below is a reproduction of the interpretation of ‘EIS - qualifying trades’ published in Tax Bulletin 54 (August 2001). ICTA88/S297 has been rewritten to ITA07/PT5/CHP4.
“Enterprise Investment Scheme - Qualifying Trades (Section 297 ICTA 1988)
(This article is an updated version of one originally published in Tax Bulletin for August 1995)
For the purposes of the Enterprise Investment Scheme (EIS), the requirements which a trade must meet if it is to be a qualifying trade are set out at Section 297 Income and Corporation Taxes Act (ICTA) 1988. Section 297 ICTA 1988 subsection (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 paragraph (e) of Section 297(2) ICTA 1988 - 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 25-26, Schedule 15, Finance Act 2000, Paragraphs 18-19, Schedule 14, Finance Act 2000 and Paragraph 4, Schedule 28B, ICTA 1988, respectively.
This 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) ICTA 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.
Receiving Royalties and Licence Fees
Royalties or licence fees will be received where property rights of certain kinds are exploited by granting permission to others to make use of that property. But there will be cases where, although the ‘sales’ are made under licence, the receipts are nevertheless consideration for the supply of goods - for example, the retailing of CDs.
Where there is an activity of receiving royalties or licence fees there is one exception to the general exclusion. This is set out for the EIS at Section 297(4)-(5C) ICTA 1988, as enacted by Finance Act 2000. It applies, broadly speaking, in certain cases where the receipts are attributable to the exploitation of assets such as intellectual property which have been created by the company itself or a group company.
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) ICTA 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 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.”