A recent Tax Insider article has already covered some of the restrictions to entrepreneurs’ relief (ER) introduced following the December 2014 Autumn Statement, in particular the block on an individual selling goodwill to a company that he or a related person is involved in as a participator. But this restriction doesn’t only apply to sales for cash, it can also catch cases where a trader transfers his business to a company and receives shares in exchange.
If you incorporate your business in exchange for shares there is an automatic ’relief’ that broadly treats the transfer of all chargeable assets as being sold to the company for what they cost. That cost is treated as the price paid for your shares and the company is treated as buying all the assets it acquires for their current market value. So if the company were to sell those assets for market value it would not have any chargeable gain.
Usually, if the company then continues carrying on the same trade which qualifies for ER you will be able to claim ER when you sell some or all of your shares, provided you still meet the other criteria. So you will normally have to own at least five percent of the ordinary voting shares and will not be able to claim ER on any future disposal unless you still own at least five percent at the time of the later disposal.
Pitfall: incorporation restarts the ER clock
ER is only available to you if you have owned your business, or the shares, for at least a year (and, in the case of a company, the company has been carrying on a trade throughout that year). But when you come to sell a company, even one you wholly own, that took over your own trade, you cannot count your period of personal ownership: ER only becomes available again after you have owned your shares for at least a year.
On transfers to a company made before 3 December 2014, it may be possible to save the ER on goodwill transferred to a company by making an election to dis-apply the above automatic CGT relief upon incorporation. In that case you are treated as selling all the business assets to the company, including goodwill. That means you have to pay CGT on the gains on all the assets transferred but you are getting the 10% rate and the only downsides are that you may have to pay the tax a year earlier than you would have done on the sale of the company and there may have been some change in the value of the assets between incorporation and company sale, so you still may not get the full benefit of ER.
Tip:
Opting out of incorporation relief may still be worthwhile.
Since the ER restriction only applies to goodwill, if the business has other chargeable assets that are showing significant gains, opting out of incorporation relief may still be worthwhile to get ER on those other assets. Assets that you can still claim ER on when transferring them to your company may include land and buildings, fixed plant and machinery, trademarks, copyrights, licences, franchises and designs that are not counted as revenue assets, i.e. subject to income tax on disposal.
Practical Tip:
The ER changes in December 2014 change the landscape for anyone considering setting up a new business now and affect the decision about the structure to adopt: should you use a partnership, limited liability partnership (LLP) or company from the very beginning? I will return to this topic next month.
