This Capital Gains Tax (CGT) relief is available to individuals, including trustees and partners, who are running a business and then transfer it to a new or existing limited company. This may take place for a variety of reasons, both tax and non-tax related, including, in order, the possibility of obtaining the protection of limited liability, easier access to funding and lower corporate tax rates.
With this relief, the individuals won’t pay CGT at the time of incorporation. Instead, the gain from the business is rolled into the shares of the company. This relief is given automatically by section 162 of the Taxation of Chargeable Gains Act 1992, provided that the various requirements are met. If an individual doesn’t wish to use the relief, the date by which he/she must tell HMRC will vary.
The provision made by s162 can be broken down into four conditions:
1. a person who is not a company (this includes traders or the individual members of a partnership) transfers a business to an existing or new company (transfer to an LLP would not qualify).
2. the business is transferred as a going concern. It means that the business is transferred in such a way that, at the date of transfer, it could be continued by the transferee without interruption.
3. all of the assets (with the possible exception of cash) are transferred. We are talking about assets such as stock and debtors that are not chargeable assets for CGT purposes. This also includes some assets as land and buildings that the proprietor does not wish to transfer as the transfer will give raise to SDLT, where the company is a connected person (as is likely).
4. the consideration is wholly or partly satisfied by the issue of shares. Full relief is only available if all of the consideration is satisfied by the issue of shares, therefore relief will be restricted for consideration in cash or loan notes. There is no requirement as to the percentage shareholding of the transferee after the transfer, although this may be a consideration for business asset disposal relief purposes.
The following are some of the most frequently encountered problems:
a. Market value: the transfer of assets to the company takes place at market value. In the case of goodwill, where there could be tax advantages in inflating its value, there is always a possibility of HMRC challenging it.
b. The cost of the shares: The maximum amount of gain that can be rolled over cannot exceed the former proprietor’s ‘cost’ of the shares, which will be equal to the market value of the business transferred. This should not be overlooked.
c. Business asset disposal relief:
• There is a two-year period for which the conditions must be satisfied. There is a special provision to ensure that the period of ownership of the business prior to incorporation can be aggregated with the ownership of the shares after incorporation.
• There is also no guarantee that business asset disposal relief will continue to be available in the future, particularly as it has already been substantially reduced (from an upper limit of £10m down to £1m).
• There is also the possibility to be considered are electing to disapply incorporation relief under TCGA 1992, s162A – but bear in mind that the election is all or nothing and could therefore trigger gains in excess of the business asset disposal relief limit.
Although the requirements of s162 appear relatively straightforward, the claim may not always be advantageous. It is important to consider each claim in detail to avoid crystallising any unexpected tax liabilities, and equally important to be sure that if s162 does apply, it will achieve the most favourable results for the client.