Owner managers have increasingly chosen to operate their businesses through the company medium in recent years as some regulation has reduced for the smaller company and because it is more conducive to minimising personal tax and National Insurance liabilities. Various reliefs exist for those who start as an unincorporated business who wish to transfer into a company arrangement so that tax costs can be minimised. However, it is considered that some of these reliefs are too generous with some obtaining a potentially unfair tax advantage so two key changes took place with effect from 3 December 2014.
Corporation tax relief for goodwill
Corporation tax relief is given to companies when goodwill and intangible assets are recognised in the financial accounts. Relief is normally given on the cost of the asset as the expenditure is written off in accordance with Generally Accepted Accounting Practice or at a fixed 4% rate, following an election. This is subject to the general proviso that it is a transaction on or after 1 April 2002.
The rules allow relief to be claimed even when there is continuing economic ownership, referred to as a related party transaction. For example, on incorporation of a sole trader or partnership business where the individual(s) transfers their business to a company provided that the business itself commenced on or after 1 April 2002. For valuation purposes the rules require that the goodwill in such circumstances is recognised by the related party when the asset is transferred at market value.
However, an anti-avoidance measure has been announced to restrict corporation tax relief where a company acquires internally-generated goodwill and certain other intangible assets from related individuals on the incorporation of a business.
The measure means that corporation tax relief can no longer be obtained on such assets on acquisition. Relief is still available if a loss arises on a subsequent realisation of the asset.
No Entrepreneurs' Relief
In addition, individuals will be prevented from claiming Entrepreneurs' Relief on disposals of goodwill when they transfer the business to a related company. Capital gains tax will be payable on the gain at the normal rates of 18% or 28% rather than 10%.
This means that to relieve capital gains arising on goodwill and any other affected intangibles transferred to the company, only the deferral reliefs will be available. Deferral of gains can be achieved through business asset holdover (gift) relief, Enterprise Investment Scheme holdover or what is known as 'incorporation' relief. These alternative reliefs have different criteria and conditions of usage and will result in either the individual or the related company incurring the deferred gain on a subsequent event. Please contact us for further information about these alternatives if you are considering incorporating your business.
These measures will apply to all transfers on or after 3 December 2014 unless made pursuant to an unconditional obligation entered into before that date.