Chapter 20 Transformation of owner-managed businesses Flashcards
1.1 Sale of trade and assets by an unincorporated business – impact for the seller
When an unincorporated business is sold it is treated as a sale of the individual assets of the business. They key tax considerations are as follows:
- Cessation rules will apply, and terminal loss relief may be available for losses made in last 12 months.
- Balancing allowances/charges on assets qualifying for capital allowances.
- No balancing adjustments made on buildings qualifying for SBA. Buyer takes over remaining life and claims SBAs based on original cost.
- Gains/losses on individual assets being disposed of goodwill is always a chargeable asset for individuals, use market value as deemed proceeds if disposal to connected person and if SBAs were claimed up to disposal these should be added to the sales proceeds.
- Consider availability of relief to defer/mitigate tax. BADR if sale of business within 36 months of cessation, rollover relief if re-investing in other assets, gift relief if sale at undervalue/gift and EIS/SEIS if willing to invest in shares.
2.1 Incorporation – implications for the trader
Income tax: cessation of trade for the sole trader means using the closing year rules to establish final trading income assessment. From 2024/25 closing year rules will not be relevant due to abolition of basis period rules – trader will be assessed on profits from 6 April to the date of cessation in final tax year of trade. Balancing adjustments on plant and machinery will be made, a succession election can be made to transfer plant at TWDV, and no balancing adjustments will arise.
No balancing adjustments on buildings on which SBAs have been claimed, company will take over the SBA life and is awarded allowances on original cost and not market value at transfer (unless incorporation relief is available and not disapplied). Inventory will pass at market value, giving sole trade a trading profit (election can pass at higher of cost and actual sale proceeds, shifting where the profit will occur). Utilisation of trading losses:
- Normal loss relief – set against total income then capital gains of current year and/or prior year.
- Terminal loss relief – carry back three years against trading profit on a LIFO basis.
- Incorporation loss relief – carry unrelieved losses forward and set against income from the new company only.
NICs: no longer liable to class 2 and 4 NICs.
VAT: if TOGC conditions are met, then no break and change in trade occurs. The buyer company is VAT registered (can take over sole traders’ registration), transfer then outside scope of VAT. Must consider tax status of land and buildings.
CGT: individual assets deemed to have been disposed at market value. Capital gains arise on chargeable assets transferred, usually land and buildings (SBA claimed added to MV when calculating gains arising unless incorporation relief is available and not disapplied) and goodwill. Inventory and receivables are trading assets and no gain arises. Plant and machinery is assumed to be exempt on the grounds it’s a cheap chattel.
Stamp duty: if shares are received by sole trader no stamp duty is levied as these will be newly issued shares.
2.2 Incorporation – implications for the company
CT: profits now subject to CT. any employee salaries and NICs will be deducted from trading profit. Need to consider if the company is a close company. IFAs held by sole trader are now considered a trading asset, amortisation not an allowable expense for goodwill transferred on incorporation.
SLDT: payable by company on the deemed transfer of land at MV even if there is no consideration (use total value of land and buildings to determine the tax rate).
Income tax: company now have a responsibility under PAYE to pay income tax in respect of salaries.
NICs: liability arise for class 1 NICs on any salaries taken from the company, and class 1A NICs for any benefits provided to employees.
3.1 Reliefs on incorporation – incorporation relief
Incorporation relief: can be taken where all assets (except cash) are transferred. Will rollover gains arising on incorporation against the shares of the new company. Where the consideration for the transfer of the business to the company is wholly in shares the full gain is rolled over. Where the consideration is only part shares, the amount that can be deferred relates to the proportion of share consideration received:
Gain deferred = net gains on incorporation x (MV of shares / MV of total consideration)
The gain is deferred against the base cost of the shares received. Any gain not deferred is chargeable immediately. The relief is automatic provided certain conditions are met. The conditions are:
- The business is transferred by an individual as a going concern.
- The business is transferred to a company.
- All assets (except cash) are transferred to the company – liabilities need not be transferred.
- Consideration received by the transferor includes shares in the transferee company.
An individual can elect for incorporation relief not to apply.
If incorporation relief is taken the usual approach for SBAs on disposal of a qualifying building is not taken. The SBA are not added to the sales proceeds when calculating the gains arising on incorporation. Meaning no adjustment to the cost of shares for the sole trader. Instead, when the company disposes of the building the total SBAs claimed are added to the sales proceeds when calculating the gain arising.
The transfer of a business to a company could be eligible for BADR. Incorporation relief must be taken in priority to BADR, if BADR is not available for the eventual disposal of the shares, then it may be more beneficial to disapply incorporation relief if the taxpayer can afford to pay CGT at incorporation. The claim to disapply incorporation relief does not need to be made until 34 months from the end of the tax year of incorporation. BADR cannot be claimed on goodwill unless:
- The company will not be a close company, or
- The company will be a close company, but the individual will own less than 5% in it.
3.2 Reliefs on incorporation – gift relief
Gift relief: can be taken instead of IR, useful if individual wants to keep an asset personally. This is when an individual will transfer all the assets of the business, with the exception they keep a few. The gift of goodwill to the company gives a gain which is deferred against the base cost of goodwill for the company. The transfer of inventory and receivables is at MV. The company gives shares which take on MV of assets transferred.
The disadvantage is that the base cost for the company of assets transferred is lower than under incorporation relief. The shares will have a low base cost.
4.1 Disincorporation – company transfers all assets to individual.
On disincorporation the company transfers all of its assets to its owner and generates chargeable gains/trading profits subject to CT, and the owner sells their shares generating a gain on disposal and realising any gains deferred if had previously taken advantage of incorporation relief.
When the company transfers all assets to individual:
- CT: cessation of trade leading to end of current AP. CT payable nine months and one day after date of cessation
- Capital allowances: balancing adjustments on plant and machinery can make a succession election to transfer at TWDV to avoid balancing adjustments. No balancing adjustments on land and buildings for SBAs. Individual can claim SBAs for remainder of allowable year life, based on original cost.
- Utilisation of trading losses: current year loss relief, then carry back 12 months, then terminal loss relief (losses of final 12 months can be carried back three years from start of AP of the loss against profits on a LIFO basis). If losses brought, you can carry back three years from the end of the AP of cessation against profits on a LIFO basis.
- Inventory: deemed disposal at MV but can elect to transfer at higher of cost and actual sale proceeds if sold to connected person
- Intangibles: gives rise to a trading profit on disposal, using MV as sales proceeds
- Chargeable gains: assets deemed to be sold at MV at cessation leading to capital gains or losses. When calculating gains on land and buildings, any SBAs claimed by the company up to transfer will be added to the MV when calculating the gain. Gains on assets (and profits on IFAs) could be large if gift relief claimed on incorporation.
- VAT: transfer of a business as a going concern, therefore outside scope of VAT. Consider tax status of buildings
- Impact on individual: commencement of trade for IT and NIC, goodwill transferred is a chargeable asset so amortisation is not allowable, SLDT will arise depending on assets transferred and receipt of consideration.
4.2 Disincorporation – individual sells shares
Gain on disposal of shares. The gains may be substantial if incorporation relief previously claimed. Proceeds is the market value of assets transferred less tax suffered by company on disincorporation.
The gain is proceeds less cost of shares (may be reduced if incorporation relief was claimed). Due to the tax charges, it is important to do things in a set order:
- Calculate the company gains/trading profit on the assets disposed of
- Calculate the additional CT due.
- Reduce the company net assets by this.
- Use this value as the disposal proceeds for the shares.
- Compare this to the cost of the shares.
5.1 Bankruptcy
The tax implications are:
- Cessation of trade: cessation rules and relief for overlap profits. Balancing adjustments on plant and machinery. Deregister for VAT as no longer making taxable supplies. Capital gains and losses on assets disposed of. Staff redundancies are allowable costs against trading profits.
- Trading losses: CY and/or PY claim against net income. If net income claim performed for a year possible extension against gains for the same year. Terminal loss relief is the loss incurred in the last 12 months of trading plus overlap profits. Set against trading profits of the preceding three tax years on a LIFO basis.
