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Incorporation involves the disposal of an existing self-employed or partnership business to a new entity (‘person’) in exchange for shares in the company. Any assets of the business (e.g. the business’s premises) are transferred to the company which then carries on the business as successor to the former self-employed owners.
The transfer of assets will automatically trigger a CGT charge at market value because the purchaser and disposer are connected persons.
However, there are reliefs which, if possible to claim, can reduce or at least defer the CGT chargeable.
Incorporation relief
A claim to incorporation relief (IR) will defer (‘roll over’) any CGT charge however the conditions are very specific, namely that:
- the business transferred must be as a ‘going concern’
- all of the assets of the business (with the possible exception of cash) must be transferred
- the consideration for the transfer of the business assets must be satisfied wholly or partly by the issue of shares to the sole trader/partnership
Where the consideration is fully satisfied by the issue of shares, the CGT charge is deferred until the shares are eventually sold. If the consideration is only partly satisfied (the balance possibly being in cash or as amounts left outstanding on the directors’ loan account), then the gains ‘rolled-over’ are restricted to the value relevant to the shares with the balance becoming immediately chargeable to CGT. Chargeable gains are calculated and treated as reducing the base cost of the shares; the lower the base cost the higher the potential CGT liability on the eventual disposal of the shares.
All of the assets of the business must be transferred for the claim to succeed. This means that if there is a business property then the owner must transfer the property into the company, which may not be what is wanted or be possible. In addition, should property be transferred then Stamp Duty Land Tax may be payable calculated by reference to the market value of the property on the value of transfer.
Entrepreneurs’ relief
As the sole trader or partnership business will have ceased trading on incorporation, a claim to entrepreneurs’ relief (ER) may be possible should assets be transferred. Under an ER claim the CGT charge is reduced to 10% provided that the gain together with any previous gains that benefited from ER does not exceed the lifetime limit of £10 million.
With this relief not all of the business or all of the assets need to be transferred. However, the individual must have owned the business for at least a year (two years as from 1 April 2019) and the assets used in the business itself.
ER cannot be claimed on a gain arising on the transfer of goodwill to a close company where that company is a ‘related party’ to the seller (i.e. an individual who controls or has a major interest or is a participator or associate of a participator). It is only ER on goodwill that is affected by the ‘related party’ restriction.
‘Hold-over’ relief
If IR cannot be claimed, it may be possible to claim ‘holdover relief’/'(gift relief’) on the gains that arise on transfer on an asset by asset basis.
This relief applies to disposals of chargeable assets used in a trade where the disposal is not an ‘arm’s length’ transaction. As such, the relief is commonly used in the transfer of a business to a company because it allows the debtors and creditors to be retained by the sole trader outside of the company thus allowing the company to commence with no left-over debtors or creditors.
The condition for the relief is that the asset must have been used in the trade throughout its period of ownership by the trader transferor. The CGT charge is deferred until the asset is sold.
