An individual's transfer of business assets to a corporation owned by them is considered a disposition for capital gains tax purposes. Since the sole trader and the business are related, the disposal is presumed to take place at market value. As a result, the individual would incur a capital gain on the chargeable assets at the time of incorporation. Land, houses, and goodwill are the assets most likely to produce capital gains. Via integration relief, the benefit may be deferred.
What types of transactions are eligible for incorporation relief?
To qualify for incorporation relief, a business must be a going concern and all assets (other than cash) must be transferred to the company. The sum charged by the corporation to the individual for the assets must be partially or entirely in the form of shares.
What is the formula for calculating incorporation relief?
The relief is determined by calculating the net capital gains on the sale of assets by the value of the securities received divided by the total consideration. This is the sum of incorporation relief removed from overall gains to make any remaining incorporation benefit chargeable. The fact that a benefit was left in charge may be due to the fact that the company's consideration was only partially in shares.
Since incorporation relief is a deferral relief, the value of the deferred benefit is excluded from the base cost of the company's stock. As a result, the deferred benefit will be taxable when the shares are sold later.
There is no need to file a formal petition for incorporation relief since it is automatic. It is not possible for a person to limit incorporation relief in order to ensure that the annual capital gains tax exemption is used. However, the person can take a particular amount of loan stock in order to produce a benefit equal to the annual exemption.
When would it be advantageous to seek incorporation relief?
When a company wants to buy a partnership or a sole trader's business, it is common practice to first pass the business to a newly established company in exchange for shares, claiming incorporation relief. The shares are then acquired in a "share for share" transaction by the ultimate buying entity, deferring tax on the capital gain.
The relief can also be used when a sole trader or partnership decides to dispose of an asset with a significant capital gain; the business may be incorporated, receiving incorporation relief, in order to raise the base value of the asset for capital gains purposes before the newly incorporated company sells it.
When is it not advantageous to seek incorporation relief?
If the qualifying requirements are met, incorporation relief is automatic; however, a person can choose not to have the relief applied. This would be a concern for individuals who have not used their entire business asset disposal relief cap, and particularly if they do not intend to benefit from business asset disposal relief on a subsequent disposal of the company's shares because they do not expect to meet the qualifying criteria at that later date.
When a person gifts a business asset, the donor and donee may jointly elect to postpone the benefit under the gift relief provisions. Gift relief can thus be used as an alternative to incorporation relief when a sole trader moves the business to a company at a low cost, and this is generally known as the most straightforward solution. For accounting and business advice, please contact Persona Finance [enquiries@personafinance.co.uk].
