Chapter 1 Incorporation Flashcards
1.1 Introduction
Where a sole trader transfers his business to a limit company, they are said to have incorporated the business. The sole trader could be transferring his business either to a newly formed company or to an existing company.
1.2 Income tax
Cessation of trade – incorporation brings about a cessation of trade for income tax purposes. The closing year rules need to be considered, including relief for overlap profits.
Capital allowances – on incorporation plant is deemed to be disposed which will result in balancing adjustments. Where the plant is sold to the company for consideration, the disposal value in the sole trader’s capital allowance computation is the lower of the actual consideration received and original cost. Where there is no consideration the disposal value in the sole trader’s computation is the lower of the market value and the original cost.
If any plant is purchased in the final accounting period, no AIA, FYA or WDAs are available.
Connected persons – where plant is transferred between connected persons, a joint election can be made in writing for the assets to be transferred at tax written down value.
Fixtures – where a property is transferred with fixtures qualifying for capital allowances, it is necessary to make an election to fix the value of the fittings, otherwise CA cannot be claimed.
Structures and buildings – if the sole trader claims SBA the company will be able to claim the same SBA over the remainder of the original 33.5-year period over which the relief is obtained.
1.3 Hoe to incorporate a business
You can buy a ready-made company ‘off the shelf’ which can cost £100, or set one up from scratch. The business owner will then transfer the sole trader/ partnership assets into the company. There are two ways to transfer the assets:
• Transfer the assets to the company in return for something – the company pays in shares/cash or loan notes or both.
• Transfer the assets to the company in return for nothing.
1.4 Capital gains tax
The transfer of business assets by an individual to a company is a disposal for CGT. The disposal takes place with proceeds deemed to be market value because the sole trader and the company are connected persons. The sole trader will have a capital gain on the chargeable assets at the point of incorporation. Gains on chargeable assets can be wholly or partly deferred by incorporation relief.
Incorporation relief is calculated by taking the capital gain and multiplying it by the value of shares received over the total consideration. This is a deferral relief and the gain is rollover over and set against the base cost of the individual’s shares in the company. If the value of shares received is the same as the total consideration received by the individual from the new company, the relief will cover the whole of the chargeable gain.
A chargeable gain will only arise if the business pays for the assets with something other than shares, for example loan stock. There are three conditions to be satisfied before incorporation relief is given.
• The business must be a going concern
• All assets of the trade (except cash) must be transferred to the company to obtain the relief
• The consideration paid to the individual by the company must be wholly or partly paid in shares
Incorporation relief is automatic and no claim is necessary.
Business asset disposal relief – can be claimed by sole traders/partners disposing of their businesses. Where sole traders incorporate their business, business asset disposal relief will not be available in respect of any gain arising on the transfer of goodwill. Business asset disposal relief is available in respect of any gains on the transfer of land and buildings. Individuals can claim relief for gains on multiple occasions up to a cumulative total of £1 million (£10 million prior to 11 March 2020). Where individuals dispose of assets qualifying for business asset disposal relief, the relief is given by taxing all the qualifying gain at 10%.
1.5 National Insurance
When a sole trader transfer his business to a company, he will be changing his status for National Insurance purposes. Sole traders may class 2 and 4 NICs, which businesses do not. The individual will be a director/shareholder of the company after incorporation, they can extract funds from the business by payment of salary or by the company declaring dividends to shareholders. If a salary is taken by a director class 1 primary NICs are payable by the employee. In addition employer’s secondary class 1 NICs must be paid whenever a salary is made to individuals over the age of 21, the employer can deduct the employment allowance of £4,000 from its secondary class 1 NIC bill each year. The deduction is not allowed for a one-man company.
1.6 Value added tax
No VAT needs to be charged on the transfer of a business as a going concern. The conditions for this are:
• The business transferred is a going concern
• The purchaser is or will immediately become VAT registered
• There is no significant break in trading, and
• The business carried on by the company is the same
The rules do not apply where the sole trader owns land or buildings which are transferred to the company and an option to tax has been made in respect of the land or buildings, or if the building would be standard-rated supply if sold in isolation. In this case VAT is charged at the standard rate and paid by the sole trader to HMRC.
The sole trader must deregister his sole trade business for VAT purposes within 30 days, the new company should then register for VAT.
1.7 Corporation tax
The new company must notify HMRC of its chargeability to corporation tax within three months of starting to trade. Accounts and annual returns must be submitted to companies’ house. The new company is likely to be a close company.
Goodwill needs to be considered. The goodwill will not be treated as an IFA unless the sole trader started the business after April 2002. If prior to April 2002, the company will not be able to receive tax relief for the amortisation of the goodwill in the accounts. The goodwill will be treated as a capital asset and any profit on a future ale will give rise to a capital gain.
If it was post April 2002 and the incorporation took place prior to 3 December 2014, companies will get tax relief on the amortisation of goodwill. For incorporations after 3 December 2014, the company is not entitled to corporation tax relief for the amortisation of the goodwill. The exception is for incorporations on or after 1 April 2019 if the goodwill was acquired in a third-party transaction involving the acquisition of the business either before 8 July 2015 or after 31 March 2019, relief will be at a fixed rate of 6.5% per annum of the cost of the asset.
1.8 Legal and compliance issues
The business will have limited liability. It is easier for a company to raise additional finance from banks, companies can raise equity from outside investors via the EIS, SEIS or VCT scheme. Companies can also introduce share option/share incentive schemes to incentivize and retain employees.
