Lee Sharpe looks at some of the finer points of CGT incorporation relief for property businesses.
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Incorporation relief for capital gains tax (CGT) purposes is potentially available under TCGA 1992, s 162; broadly, the business owners transfer their interest in a qualifying business, in exchange for new shares issued by the company. On a qualifying transfer, the capital gain that would otherwise arise on the disposal of the chargeable assets is postponed (or ‘rolled over’) into the shares, pending their subsequent disposal, etc.
Where a business transfer qualifies, there is no need for a claim; the relief applies automatically (although it can be actively disclaimed under TCGA 1992, s 162A).
Generally speaking, most of the effort involved in making a successful claim has tended to orient around three key aspects:
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Does the activity qualify as a business?
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Have all the assets comprised in that business been transferred to the company?
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Is any restriction required in terms of the gain that may be postponed?
This article looks at these themes, but also some of the finer points that may be of interest to those undertaking incorporations.
Is it a business?
This part of the path is fairly well-trodden, particularly in the context of rental properties, and thanks largely to Ramsay v HMRC [2013] UKUT 0226 (TCC). The ‘trap’ here is familiarity; people instinctively follow income tax law and its everyday treatment, which broadly describes all income from property as arising from ‘a property business’ (at the beginning of ITTOIA 2005, Pt 3) but does not actually stipulate that all rents from property amount to a business in the wider sense (as might then apply to, say, CGT).
HMRC’s position is partly set out in its Capital Gains Manual at CG65715, although I find its insistence that a landlord spend at least 20 hours a week on the letting activity as some sort of minimum threshold to qualify as a ‘business’ to be a quite simplistic interpretation of the Ramsay case, and some way from the spirit of, say, Griffiths v Jackson [1982] 56 TC 583 and Salisbury House Estate Ltd v Fry [1930] 15 TC 266, notwithstanding the niceties of American Leaf Blending v Director-General of Inland Revenue [1978] 3 All ER 1185, that HMRC seems to prefer.
HMRC also seems to dislike where the letting activity is delegated to an agent (e.g., a property management or letting agency), although this, too, is questionable. For example, HMRC would typically be perfectly happy to find that a taxpayer using an agent was ‘in business on their own account’ in a trading scenario.
Have ALL the assets been transferred?
The legislation at TCGA 1992, s 162 requires that the business be transferred as a going concern and that all business assets be transferred ‘other than cash’; HMRC states at CG65710 that this means everything that is an asset, except for cash and sums held on bank deposit or current account. Notably, this goes beyond simply the ‘chargeable assets’ that will trigger CGT, such as property, and includes goodwill even if it has not been included on the balance sheet to date (it would comprise part of the business as a ‘going concern’, regardless).
But what of assets that a business owner might want to keep personally – or does not want to ‘lock up’ in their new company?
It is understood that HMRC generally applies this rule quite strictly, in particular so that cherished assets may not be retained or ‘held back’ in personal ownership. But this should not prevent the landlord from disposing of some assets naturally in the run-up to incorporation, so long as the remaining business is still counted as a ‘going concern’, able to stand on its own two feet in the commercial sense.
Finer points on ‘all the assets’
There has been some discussion in the professional press recently over whether or not HMRC’s approach is too rigid (or whether some advisers’ approach might have been too lax), and the Chartered Institute of Taxation has even written to HMRC (in late 2024) for clarification on whether HMRC should object to:
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the landlord retaining debtors as well as cash – perhaps to be able to settle residual liabilities;
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the landlord retaining the freehold in properties and granting a leasehold to the company on incorporation; or
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the landlord being able to retain the legal title to the properties being transferred while the beneficial interest is passed to the company.
For instance, it is not difficult to see where a landlord might own the freehold in a mixed-use property but let out only the residential part; having to transfer the freehold might effectively require the landlord to transfer ‘more’ than is actually being used in the letting business. If we work on the basis that the key aim in the statute is to ensure the transfer comprises a viable business, it is also difficult to see why HMRC might insist on the transfer of legal title as well as beneficial ownership (at least to the extent of England and Wales; Scotland has its own peculiar rules in relation to ‘ownership’ – although it would no doubt argue that it is England and Wales who are peculiar!).
What about the business liabilities?
Incorporation relief is granted on the basis that the company is offering (new) shares in itself in consideration for the valuable business. It follows that if the company offers cash, or any other non-share consideration, this restricts the relief.
In the past, HMRC argued that the company’s taking on some or all of the business’s liabilities amounted to such non-share consideration, but this was put right by Extra-Statutory Concession (ESC) D32, which permitted the company to ‘take over’ some or all of the business’s liabilities without it counting as consideration alongside the shares – although it does still speak to the value of those shares.
One of the key traps is that the gain starts to be exposed (i.e., may not be fully postponed) as the value in the shares falls; simply, the company is worth less if the business is heavily financed, so a heavily geared business (or its landlord) may either have to suffer some CGT that cannot be postponed, or leave some liabilities outside the company, for the landlord still to contend with. This may easily be the case where the properties have been heavily remortgaged, say, to capitalise on their increased value over time, and the additional funds released have not been applied to enhance the business.
Finer points on ‘business liabilities’
The CIOT has also written to HMRC to clarify the scope of ESC D32, pointing out that banks and other lenders generally no longer allow companies to take over mortgages, etc., by ‘novation’ but by the implementation of entirely new terms (i.e., new arrangements), where the new borrowing in the company is then used to settle the old borrowings – largely the same outcome, but a quite different path to get there. So, much hangs on how literally HMRC seeks to apply the idea that the company ‘takes over the liabilities of the [old] business’ (not that literally, in my experience).
Finally, it seems that HMRC is getting upset over the idea that landlords might extract their capital prior to incorporation and then introduce loans to the company after incorporation. HMRC smells avoidance (I smell fundamental ignorance of accounting principles - worse even than mine!). HMRC seems to have forgotten that business capital was always the landlord’s money (at least on the usual historical cost basis).
Conclusion
One used to be able to ask HMRC for ‘advance non-statutory clearance’ to confirm that it would not object to the application of the relief in a given scenario; for example, if one property out of the portfolio was currently under negotiation for sale, it would likely be expedient not to transfer that to the company, but HMRC would want to be satisfied that it was being excluded for purely commercial reasons, and that the remaining properties comfortably amounted to a lettings business. Alas, HMRC has refused to give such clearances for property business incorporations since around 2018.
We await such clarifications as HMRC may offer, with bated breath. Meanwhile, CGT incorporation relief should be approached carefully.
