Sarah Laing looks at some of the potential problems surrounding the restricted tax relief available in some cases when a limited company disincorporates.
Disincorporation relief, which was introduced from 1 April 2013, is designed to remove certain tax barriers that previously existed when a company transferred business assets to its shareholder(s), who carried on the business as a sole trader or partnership. The relief is particularly relevant to small companies, but there are some potential problems to be aware of.
A ‘limited’ relief
Broadly, disincorporation relief:
- allows a company to transfer its goodwill and land to its shareholders without a corporation tax charge arising on the transfer;
- requires the transfer of the company’s business, as a going concern, to its shareholders;
- does not apply to stock or work in progress;
- only applies to companies with qualifying assets with a total value of up to £100,000 (‘qualifying assets’ are goodwill and land and buildings used in the business).
However, the relief does not extend to any income tax charges that might arise on the shareholders where the company’s assets are distributed to them.
The assets transferred to the shareholders will be treated as ‘dividends in specie’. As long as this does not push the shareholders into the higher rate there will be no further income liability for the shareholders. Higher and additional rate taxpayers will face an income tax charge.
The underlying rationale for the relief was that it should mirror the reliefs available where an unincorporated business incorporates, so that a business would not face a tax charge solely for changing its legal form. The key problems, however, are the monetary limit on assets and the lack of relief for shareholder gains.
Watch out for the asset cap
The £100,000 asset cap has raised particular concerns within the tax profession. A company may be at risk if it transfers its business to its shareholders and subsequently finds out that HMRC’s idea of ‘value’ means that the £100,000 limit has been breached. This could very easily happen in relation to goodwill. Many small firms will not have given thought to the real value of their goodwill and, even with proper advice, it will be impossible for shareholders to know in advance what valuation will be acceptable to HMRC. If the limit is breached, no relief is due and the company may receive an unexpected corporation tax bill.
The asset cap potentially has the bizarre effect that a company that has created its goodwill from nothing could get relief on gains of up to £100,000, whereas another might have made gains of only £10,000 but be ineligible for the relief because its qualifying assets were worth £105,000.
Gains on assets
Transfers of assets between a company and its shareholders are normally transfers between connected persons or related parties. Usually transfers between connected persons or related parties are treated as taking place at market value for tax purposes - the result being that the transfer is taxed on the market value of the asset regardless of the amount paid by either party. This could result in the company having to pay a corporation tax charge in cases where the market value of the asset is more than its original cost or its tax written down value.
A claim to disincorporation relief allows qualifying assets to be transferred below market value so that no corporation tax charge arises to the company. The shareholders accept the reduced transfer value for all future capital gains computations.
Shareholders may still be liable to tax on the transfer of assets to them by the company. Shareholders may also be liable to capital gains tax if they dispose of the assets at a future date.
Practical Tip:
As claims are made jointly by the company and shareholders, a claim cannot be made if the company has already been closed down (i.e. struck off or wound up).
