Reshma Johar considers what options a sole trader or partner of a partnership have when their unincorporated business is transferred into a company.
On incorporation, a taxpayer will have a choice between the use of either gift relief (TCGA 1992, s 165), incorporation relief (TCGA 1992, s 162), or simply paying the capital gains tax (CGT) at the time of disposal.
Given that the taxpayer has a choice of potentially the two reliefs, it will be a matter of understanding the current and future intentions of the taxpayer to determine which relief is best.
More about the reliefs
Incorporation relief will be available broadly where the following conditions are met:
- the business is transferred as a going concern;
- all assets of the trade (except cash) is transferred into the company; and
-
the consideration paid to the taxpayer is wholly or mainly in shares.
Whilst there is no set percentage of what wholly or mainly in shares would be, HMRC’s Business Income manual (at BIM85060) stipulate that ‘mainly’ means at least 80% of the shares.
Sizing up the reliefs: The differences
Incorporation relief is applied automatically if the relevant conditions are met. If the taxpayer did not want the relief to apply, they would need to opt-out by notifying HMRC within one year following the 31 January anniversary of the self-assessment filing date for the tax year of the incorporation.
Gift relief requires the transferor and transferee to make a joint claim to HMRC within four years from the end of the tax year in which the disposal was made.
Incorporation relief refers to the transfer of a business, which can also include a trade. Gift relief is restricted to business assets that are used by the taxpayer for the purpose of their trade (including profession or vocation) or agricultural property.
Where gift relief is claimed, the chargeable gain arising from the transfer of a business asset is generally reduced by the amount of held-over gain (which could wipe out either part or the entire gain). The transferee acquiring the asset will also acquire the held-over gain. The held-over gain is deducted from the market value of the asset transferred.
By contrast, under incorporation relief where the chargeable gain arising from the transfer of the entire business to the company is wholly in exchange for shares, the gain arising on the disposal is deducted from the base cost of the shares in the company. If you receive part of the consideration in cash, this will reduce the amount of incorporation relief available to you. Instead, the cash will generally be treated as a credit in your director’s loan account, which you can withdraw from the company without any further tax charges.
Gift relief has clawback provisions, which means that a deferred gain can come back into charge and be assessed on either the transferee or, in some cases, the transferor. Incorporation relief does not have any clawback provisions.
Losses of an unincorporated business can only be carried forward and utilised by the taxpayer if incorporation relief is applied.
Each individual partner of a partnership will be able to choose whether to use gift relief or incorporation relief.
Before bets are placed…
Gift relief is often used instead of incorporation relief where the taxpayer wants to retain a property outside the company because it holds significant value and the property could be a source to generate rental income from the company. If the property is transferred into the company, stamp duty land tax (SDLT) (in England and Northern Ireland) will be due if there is any consideration in money or money’s worth.
It may also be necessary to consider business asset disposal relief (BADR), which could be claimed on the disposal instead of applying either gift relief or incorporation relief. Whilst the business may meet the qualifying conditions for BADR now, the shares in the incorporated business may not in the future.
If the taxpayer has a large capital loss brought forward from a previous asset disposal, it may be worth considering utilising this now rather than waiting. The company would acquire the business assets at current market value; this would result in a higher credit in the director’s loan account for the director to draw upon tax-free. It also means that the value of the business and assets is not locked into the shares, as it would do under incorporation relief.
Practical tip
Taxpayers should consider the impact of reliefs for both now and in the future, such as the sale of company shares or trade and assets.
