Finance Bill update: Disincorporation Relief

Disincorporation relief is new a tax relief which takes effect from 1 April 2013 and will operate for five years.  It is aimed at companies who wish to carry on their business activities through a non-corporate structure.  The relief is being introduced to remove the tax barriers that currently exist when business assets are transferred by a company to shareholders who wish to continue the business as a going concern in an unincorporated form.

The principal advantage will be that, provided the relevant conditions are satisfied, capital gains will not arise on the disposal of the company’s qualifying assets (QAs).

Key features

  • Transfer of QAs with an aggregate value of £100,000 or less will not crystallise a capital gain.
  • The relief is available for a period of five years commencing from 1 April 2013.
  • No relief is available for the tax charges which may arise on the shareholders when assets are distributed below market value in the course of a disincorporation.

There are no conditions stipulating how long the company has to have been in existence therefore the relief could apply to relatively new companies as well as those which have been in existence for several years.

Conditions

A claim can be made where all of the following conditions are satisfied:

  • A company transfers its business to some or all of the shareholders of the company,
  • The transfer of the business is a qualifying business transfer, and
  • The business is transferred within 5 years after 31 March 2013.

Definition of a qualifying business transfer (QBT)

A transfer of a business from a company to some or all of the shareholders will be treated as a QBT if all of the following conditions are met:

  • The business is transferred as a going concern.
  • The business is transferred together with all of its assets other than cash.
  • The market value of the businesses’ QAs does not exceed £100,000.
  • All the shareholders to whom the business is transferred are individuals (or partners of a partnership but not members of a LLP).
  • Each of the shareholders to whom the business is transferred have held their shares throughout the 12 months immediately prior to the date of transfer.

Qualifying assets (QAs) are defined as:

  • Goodwill, or
  • An interest in land which is not held as trading stock.

Effect of the relief

Transfers of QAs (including goodwill created before 1 April 2002)

These will be deemed to have been sold by the company and acquired by the shareholders for consideration equal to the lower of:

  • The total of the acquisition price PLUS any enhancement expenditure incurred on the QA PLUS any incidental costs incurred as a result of the transfer, and
  • The market value of the QA.

Transfers of goodwill created after 31 March 2002

The treatment of goodwill created after 31 March 2002 depends on how it has been recognised in the company’s accounts, as follows:

  • Shown in the balance sheet and written-down for tax purposes

The transfer is treated as being at the lower of:

–          The tax written-down value of the goodwill, and

–          The market value of the goodwill.

  • Shown in the balance sheet and not written-down for tax purposes

The transfer is treated as being at the lower of:

–          The cost of the goodwill, and

–          The market value of the goodwill.

  • Not shown in the balance sheet

The goodwill is treated as being transferred for nil consideration.

Corporation tax implications of transferring the trade and assets

As explained above, capital gains will not arise on the company’s goodwill or interests in land (which are not held as trading stock). However the company may own other items such as stock and plant and machinery which can be subject to tax charges if they are transferred. Fortunately there are other reliefs to mitigate the tax charges which can arise on the transfer of these:

Stock

An election can be made under ITTOIA 2005 s 178 between connected parties to transfer any stock at the higher of cost or the price paid. This can eliminate any taxable profits which may arise on the transfer to the new unincorporated business.

Plant and machinery

An election under CAA 2001 s 266 can be made between connected parties to transfer plant and machinery at tax written-down values. If this election is made then neither a balancing charge nor a balancing allowance will not arise on the transfer of these items.

Definition of connected persons

The shareholder(s) to whom the business is transferred and the company will be treated as connected for the purposes of an election under either ITTOIA 2005 s 178 or CAA 2001 s 266 if the shareholder(s) to whom the business is transferred own 51% or more of the company’s voting share capital or profits or assets on winding up of the company.

Therefore as most small companies are only likely to own capital items, stock and QAs and it is likely that the company and the shareholder(s) to whom these assets are transferred to will be treated as connected then it should be possible for them to eliminate all of the corporation tax charges which may arise should they wish to disincorporate.

Potential tax issues

Transfers to the shareholders at below market value

Whilst disincorporation relief in conjunction with other tax reliefs can mitigate the corporation tax charges which may arise if the trade and assets are transferred to the shareholder(s), there are no reliefs for the tax charges which may arise personally on the shareholder(s) to whom the business and its assets are transferred. If these are transferred at below market value they will be treated as a dividend in specie on which they will be subject to tax. This treatment will also apply to any cash transferred to the shareholders.

Losses

If the trade was originally transferred to the company by a sole trader/partnership and an election was made under ITA 2007 s 86 to carry forward and offset any trading losses against future dividend income this will be lost i.e. these losses cannot be transferred and offset against future income from the business continued on by the shareholder(s).

If the company has losses these cannot be transferred to the shareholder(s).

Making a claim

A claim must be:

  • Made jointly between the company and all of the shareholders to whom the business is transferred, and
  • Made within 2 years of the business transfer date. If the business is transferred under more than one contract then the business transfer date is taken to be the contract date under which the goodwill is transferred.

Once made a claim is irrevocable.

For further information in relation or advice about the incorporation of disincorporation of a business please contact the TaxDesk on 0845 4900 509 and ask for Martin Mann.