Business owners, both sole traders and partnerships, were dealt a blow in the Autumn Statement of December 2014 when the option of selling goodwill to a connected company and claiming entrepreneurs’ relief (ER) was removed. The change also saw companies lose the chance to claim corporation tax relief on goodwill acquired from connected individuals. So what’s left now for a business thinking of incorporating?
Restriction only applies to goodwill
The restriction doesn’t stop other chargeable assets used in the business being sold and entrepreneurs’ relief claimed, but you have to consider carefully what the effect of selling will be in the long term as well as the short term.
The most likely asset for selling into a company is the property used in the business but that carries two additional costs as well as the 10% capital gains tax (CGT) rate. First is stamp duty land tax (SDLT) at up to 4% on non-residential property (on properties over £500,000). If that price is worth paying to get value into your company, remember that the company is now liable for corporation tax on any gain it makes on selling the property: that’s 20% on the gain and paying another 10% on winding up the company makes your overall tax rate on future gains 28% at best, and only if your company still qualifies for entrepreneurs’ relief by then.
Once you get past property and goodwill the number of assets that actually qualify for entrepreneurs’ relief is relatively small. If you make a profit from selling: commercial or technical know-how; unregistered trademarks or designs; copyright; or, usually, patents, you will pay income tax which means that entrepreneurs’ relief is irrelevant. Registered trademarks and designs, some patent rights and franchises are subject to CGT and so may attract entrepreneurs’ relief, but you are still facing double taxation on eventual sale. Intellectual property rights also, like any other asset, need a value to be established and the benefit of the tax saving will be diminished if HMRC dispute your value.
How can I incorporate now?
If you’re incorporating a business with substantial goodwill you have two options for doing so without paying tax on the goodwill transfer.
You can incorporate in exchange for shares, which requires the entire business to be transferred to the company in one go. Usually this is a straightforward process unless there are assets that you want to keep out of the company. You can only hold back cash when transferring the assets of the business. This means that if you own the business premises they must be transferred in too. If that’s the case you will have SDLT to pay on the property transferred in and may have to reorganise any borrowings on the premises by transferring them to the company. This option has the benefit that the company is treated as acquiring all of its CGT assets at their current market value, so counting as base cost for when the company sells, even if that sale comes along immediately afterwards.
The CGT ‘base cost’ of your shares, the price allowed as their cost, is usually the current market value of the assets transferred in (reduced by older gains rolled over against them), so you don’t lose out on the costs you’ve already incurred.
The other way of incorporating is to transfer the assets that you want the company to own to it by way of gift. This is usually less favoured because the company doesn’t get any ‘uplift’ on the assets’ value, and if it sells them only the original cost to you, plus any improvement costs etc., is deductible. Also you only count the actual amount subscribed for your shares as their base CGT cost.
Practical Tip:
If you want to incorporate your business but keep an asset such as the business premises in your personal ownership, this could be a good time to bring your spouse into the business. If you form a partnership and keep the premises ‘off balance sheet’ they don’t count as assets of the business and you can still incorporate for shares.
