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Business Services  •  Business Tax  •  Entrepreneur's Relief  •  Personal tax  •  Small Business  •  Tax Planning  •  Tax Relief

Incorporation relief shouldn’t be overlooked for goodwill transfers

By Lesley Stalker on 26 February 2015

We recently blogged about the fact that incorporation using entrepreneurs’ relief is no longer available following recent changes in legislation. Full details of this are included in our recent blog: 

Whilst there can be other benefits to running a business through a limited company rather than as a sole trader, partnership or LLP, it means it is no longer possible to achieve the large tax savings that were previously available on incorporation itself.

Are there however other alternatives available on incorporation which compensate for the lost tax relief? One possibility is to use incorporation relief, which has been much neglected in recent years.

Here’s how incorporation relief works:

When business assets (usually goodwill) are transferred by one or more individual into a limited company which is controlled by them, this is classified as a disposal for capital gains tax purposes; the disposal is deemed by HMRC to have taken place at open market value because the parties involved are connected. Using entrepreneurs’ relief relies on allowing the capital gain to crystalise and paying the capital gains tax (at 10%). But now that entrepreneurs’ relief is no longer available on such gains, the rate of capital gains tax is 28% for goodwill transfers involving connected parties, and allowing the gain to crystalise is not so attractive.

One alternative is to use incorporation relief, which is effectively a deferral relief. The deferred capital gain is rolled over and offset against the cost of the shares acquired in the company, so any tax payable will effectively be charged when the individual eventually sells his shares.

There are 3 conditions which must be satisfied before incorporation relief can be claimed:

  1. The business transferred must be a going concern;
  2. All assets owned by the business (except cash) must be transferred to the limited company. Therefore if assets such as land and buildings are owned, which the owners do not wish to be transferred to the limited company, they should be removed into personal ownership in advance. If this is not attractive, the gift relief rather than incorporation relief can be considered;
  3. The consideration paid for the business assets must be wholly or partly in shares.

 

Using the example in our earlier blog:

The Smith Partnership is valued at £100,000 and the partners decide to incorporate into The Smith Company Limited, owned by the same individuals.

The gain on the transfer of goodwill is £100,000

Incorporation relief is calculated as the gain x the value of the assets received/ total consideration.

Assuming no consideration is received for the goodwill other than shares, the incorporation relief is £100,000.

 

The relief is automatic, with no formal claim being required, and it cannot be restricted in order to make use of the annual capital gains tax exemption. (This could be done however by taking a small amount of cash into a director’s loan account, which will create a chargeable gain that can be calculated to be equal to the capital gains tax exemption).

When the shareholders of The Smith Company Ltd eventually sell their shares, the chargeable gain will be increased by £100,000 and entrepreneurs’ relief will be available, providing all the qualifying criteria are met.

Ultimately the total tax payable and net gain to the business owner is comparable to the former approach using entrepreneurs’ relief, but ensures relief is only given on a genuine business sale, rather than on the manufactured sale scenario of incorporation. Nevertheless, incorporation relief remains a useful option where there are other reasons to incorporate a business; and let’s hope this relief isn’t taken away as HMRC continues to find ways to generate more revenues from taxpayers.

If you would like to discuss incorporating a business, please contact Lesley Stalker by emailing las@rjp.co.uk

 

 

 

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We recently blogged about the fact that incorporation using entrepreneurs’ relief is no longer available following recent changes in legislation. Full details of this are included in our recent blog: 

Whilst there can be other benefits to running a business through a limited company rather than as a sole trader, partnership or LLP, it means it is no longer possible to achieve the large tax savings that were previously available on incorporation itself.

Are there however other alternatives available on incorporation which compensate for the lost tax relief? One possibility is to use incorporation relief, which has been much neglected in recent years.

Here’s how incorporation relief works:

When business assets (usually goodwill) are transferred by one or more individual into a limited company which is controlled by them, this is classified as a disposal for capital gains tax purposes; the disposal is deemed by HMRC to have taken place at open market value because the parties involved are connected. Using entrepreneurs’ relief relies on allowing the capital gain to crystalise and paying the capital gains tax (at 10%). But now that entrepreneurs’ relief is no longer available on such gains, the rate of capital gains tax is 28% for goodwill transfers involving connected parties, and allowing the gain to crystalise is not so attractive.

One alternative is to use incorporation relief, which is effectively a deferral relief. The deferred capital gain is rolled over and offset against the cost of the shares acquired in the company, so any tax payable will effectively be charged when the individual eventually sells his shares.

There are 3 conditions which must be satisfied before incorporation relief can be claimed:

  1. The business transferred must be a going concern;
  2. All assets owned by the business (except cash) must be transferred to the limited company. Therefore if assets such as land and buildings are owned, which the owners do not wish to be transferred to the limited company, they should be removed into personal ownership in advance. If this is not attractive, the gift relief rather than incorporation relief can be considered;
  3. The consideration paid for the business assets must be wholly or partly in shares.

 

Using the example in our earlier blog:

The Smith Partnership is valued at £100,000 and the partners decide to incorporate into The Smith Company Limited, owned by the same individuals.

The gain on the transfer of goodwill is £100,000

Incorporation relief is calculated as the gain x the value of the assets received/ total consideration.

Assuming no consideration is received for the goodwill other than shares, the incorporation relief is £100,000.

 

The relief is automatic, with no formal claim being required, and it cannot be restricted in order to make use of the annual capital gains tax exemption. (This could be done however by taking a small amount of cash into a director’s loan account, which will create a chargeable gain that can be calculated to be equal to the capital gains tax exemption).

When the shareholders of The Smith Company Ltd eventually sell their shares, the chargeable gain will be increased by £100,000 and entrepreneurs’ relief will be available, providing all the qualifying criteria are met.

Ultimately the total tax payable and net gain to the business owner is comparable to the former approach using entrepreneurs’ relief, but ensures relief is only given on a genuine business sale, rather than on the manufactured sale scenario of incorporation. Nevertheless, incorporation relief remains a useful option where there are other reasons to incorporate a business; and let’s hope this relief isn’t taken away as HMRC continues to find ways to generate more revenues from taxpayers.

If you would like to discuss incorporating a business, please contact Lesley Stalker by emailing las@rjp.co.uk