Tax issues on incorporation
If you are considering forming a limited company and incorporating your business, there are various tax issues to consider. The most important one is often capital gains tax (CGT). This will be relevant if your business includes certain assets such as goodwill and buildings that may be subject to the tax when you sell the business to the company. However, there are different methods of transferring assets to a limited company which can help avoid CGT liabilities.
1. Sell the assets to the new company
This is normally the most popular method of transferring assets to your company. When you form your company, it will probably not have the funds to buy the assets yet. However, a director's loan account can be created in the company accounts so that when the company does have sufficient funds, it can pay the loan back to the director. Provided the director does not charge interest on the loan, the repayments will be tax free in the hands of the director.
However, with this method you may still have some CGT liabilities if there is a gain on the sale of the assets. But provided certain conditions are met, any gains above your annual allowance should qualify for entrepreneurs' relief and only be taxed at 10%.
2. Claim incorporation relief
Incorporation relief may be claimed where you transfer your business to a company as a going concern. The whole of the assets of the business (other than cash) must be transferred wholly or partly in exchange for shares issued by the company to the transferor. Any chargeable gain on the disposal of the assets is deferred by holding over the gain against the base cost of the shares in the new entity. The relief applies automatically if relevant criteria are met but may be disapplied.
This method is useful if you want the company to show a strong balance sheet from the outset or you want any gains to be totally avoided. But the disadvantage is that the director does not have any funds in his loan account from which to draw tax free because it is all tied up in the value of the shares instead. Most small businesses will therefore not normally choose this option.
3. Claim hold-over relief
Hold-over relief may be claimed if the whole of the business does not need to be transferred and if certain assets are preferred to be kept outside of the company. The held-over gain is then set-off against the base cost of the relevant assets within the company.
This method is useful if you want to keep a property outside of the company and prefer instead for the company to pay a rent for the property. This will have certain tax advantages but it is important to note that this can mean that the owner will lose entitlement to entrepreneurs' relief on the property, because the property would then be regarded as an investment property.
Which method is right for me?
We can help you choose which approach is the right one for you. The choice will probably depend on your current tax liabilities and your longer term plans as each option will have a different impact on the calculation of any capital gain when you later sell the company or the company sells the assets.
It is often more efficient to leave property outside of a company. Stamp duty land tax may be payable in any case if the sole trader sells it to the company and there may be a CGT liability unless one of the reliefs is claimed.
Advantages of property in a company
10% entrepreneurs' relief will be available when the company (and property) is sold. This would not be available if it is outside of the company and a rent is charged, because it would be a property investment. Another complication is that unless a rent is charged, the owner would not be able to claim associated costs such as mortgage interest payments etc. However, entrepreneurs' relief is only lost from the date the property becomes an investment, so it would be available for the time when it was owned by the business.
Indexation relief is available to minimise any gain on a property if it is later sold by the company at a profit. This may work out better than annual allowance and any profit would be taxed at corporation tax rates instead of CGT rates.
There will also be the option to tax for VAT purposes if the company is VAT registered.
Advantages of property outside a company
There will be no capital gain or stamp duty to pay if the property is not sold to the company and you will not have the same issues again if you wanted to remove the property from the company at a later date.
The annual allowance for CGT may be better than indexation relief and CGT rates may be better than the corporation tax rates.
Mortgages in the director's name
If a property is put into the company name and it has a mortgage on it in the taxpayer's own name, for the company to be eligible for tax relief on the interest payments, a new mortgage must be taken out in the company name. It is unlikely that a bank will allow the transfer of ownership anyway because of the charge they hold. If the property is transferred and there remains a loan in the director's name then there will be further complications for tax.
VAT and PAYE
You can transfer the same VAT number that you have as a trader if you want to. However, you must set up a new PAYE scheme, but you can ask HMRC to transfer employees rather than complete P45s etc.
You can make an election to transfer capital assets at their tax written down values and continue with the same capital allowances if you wish. However, if you are doing this, the trader cannot claim any allowances in their final period of trading.
Alternatively, the assets may be sold to the company at whatever value the trader wishes and balancing charges or balancing allowances may occur as necessary. Consideration is needed as to whether the trader is better off paying balancing charges or whether the company would be better paying them in the future. We can help you decide which method is best for your circumstances.
Capital gains tax
Please read the following pages to learn more about CGT:
This information is not meant as a substitute for professional advice and by no means covers every scenario. Almost every rule described here will be subject to many exceptions and caveats. Tax legislation is extremely complex and can be difficult to understand. You should discuss your circumstances with a qualified professional before acting on any information contained within this website. Tax legislation is constantly changing and the information contained within this website is written from our current understanding and interpretation of the tax system as of 6 April 2017.