Case developments: When does a trade commence?
Whilst questions around when a trade factually commences require us to consider the broad commercial substance of a business, this can nonetheless be an intricate and technical exercise. The question has not been heavily litigated in recent years but there have now been two tribunal cases considering this exact point in recent months.
This insight summarises the different approaches of the First-tier Tribunal (FTT), as it adopted contradictory views on the practical application of the relevant legal test across the two cases, and reflects on what lessons can be learnt.
Why the commencement of a trade important?
The question of when a trade commences is important, given how it may dictate:
- when an accounting period starts and the obligation to register for corporation tax arises;
- when a qualifying business activity comes into existence and the time when claims for capital allowances can be made regarding pre-commencement capital expenditure;
- the treatment of certain losses and the ability to surrender and claim relief for tax losses under provisions such as group relief; and
- the availability of certain tax reliefs, such as business asset disposal relief (BADR), seed enterprise investment scheme (SEIS) relief and enterprise investment scheme (EIS) relief.
The above list is not exhaustive but illustrates the wide relevance of the question considered here. In particular, we often observe this as a possible area of concern as part of our tax due diligence services in the context of corporate transactions, where the historic failure to proactively consider this point can subsequently lead to tax irregularities being uncovered.
How do we determine trade commencement?
The two recent cases alluded to above are J Wardle v HMRC [2024] UKFTT 543 (TC), released in June 2024, and Putney Power Ltd and another v HMRC [2024] UKFTT 870 (TC), in September 2024. Both cases deal with similar factual circumstances in that they both involved businesses in the energy sector seeking to begin producing electricity at their respective sites. Both cases considered the date of commencement of trade in the context of certain tax reliefs for shareholders.
J Wardle considered whether the relevant entity had been trading for a sufficient period of time to meet the requirements for entrepreneurs’ relief (the predecessor to BADR), whereas Putney Power considered whether the trading period under EIS was met. Whilst the cases considered the position concerning these specific reliefs, the findings can have a much wider impact on the tax profile of a business.
The facts are not analogous, given the complex contractual arrangements. However, there is enough commonality in how the FTT summarises and applies the jurisprudence in this area. Both cases agreed on the correct test to apply. The test for a trade to commence is broadly that:
- the business must have a specific idea of the type of activity which is to be carried on;
- the business structure must have been set up to the extent necessary (ie the business must assemble their operational infrastructure); and
- the business must start operational activities by taking steps to expose itself to real operational risk and reward.
In both J Wardle and Putney Power, the FTT had found that the extensive contractual arrangements entered into by the businesses were sufficient to constitute operational activity (although only one of the two businesses in Putney Power met this threshold). The difference of opinion arose in the context of the second stage of this test and the extent to which the operational infrastructure had to be established for the trade to commence.
The FTT in J Wardle concluded that the complex web of contracts which, if performed, would have resulted in the establishment of trade infrastructure was sufficient to satisfy the second stage of the test, as this meant that “the train was on the tracks travelling to its destination”. The conclusions in J Wardle therefore equate trade commencement to a trade potentially being set up to a sufficient degree even where the business is not yet in a position to supply its goods or services.
The FTT in Putney Power took a contradictory view on this point, concluding that the business must be “open for business” and they must have assembled the necessary operational infrastructure to be in a position to provide those goods and services.
What can we learn from these decisions?
Neither of these cases set a binding precedent that a future tribunal or court would be obliged to follow. However, both cases do explore the commencement of trading activities in some detail, thereby offering invaluable guidance on the correct test to apply and the different ways that it can be interpreted.
Our view is that the decision in Putney Power takes a more sensible view on the jurisprudence in this area. It seems natural that the trade should only commence when a business is actually “open for business” and in a position to supply goods or services. This conclusion in Putney Power does seem to have intuitive appeal by analogy to, for example, a restaurant where we might expect it to commence trading when it opens its doors and is ready to start serving customers. The alternative analogy in J Wardle of a train being on the tracks travelling to its destination seems, in our view, to have less intuitive appeal.
Application to renewable energy projects
The findings in these cases are likely to be of particular relevance to businesses operating in the electricity generation sector. These companies are often set up as special purpose vehicles to operate a single electricity-generating station. As a result, there can be a significant period of delay between the date of incorporation and the date on which the business is capable of producing electricity (as sites are identified, planning sought and construction completed).
In our experience, tax attributes (eg losses and capital allowance values), which are contingent on trade commencement, can often be a key modelling assumption in determining the future cash flows of renewables businesses. Ensuring that such attributes are correctly valued in any M&A transaction, and that appropriate commercial protections can be sought, can be key to assessing the commercial viability of an acquisition or disposal.
The view taken by the FTT in J Wardle would indicates that a renewable energy trade may commence at some point before the date on which the business is capable of producing electricity. This conclusion conflicts with commercially established custom in the sector where trade commencement is typically closely linked to the date on which a commissioning certificate is issued by Ofgem. The conclusion in Putney Power, which we consider to be more persuasive, appears to more closely reflect the commercial norm.
Given HMRC has indicated that they have appealed J Wardle, it appears that HMRC is more closely aligned with the widely applied commercial norms. However, it will be interesting to see what findings the Upper Tribunal makes on appeal. Should this result in a different conclusion to that reached in Putney Power, taxpayers may need to reconsider the basis on which returns are filed and the calculation of any tax attributes.
However, in the absence of further clarity from the tribunals or higher courts on this issue, this is now an increasingly complex area to navigate for both businesses and investors. If you need to navigate these complexities and want to explore how our corporate & business tax experts can assist you, please do contact our team below.
