ACCA ATX ^UK Syllabus A2. Chargeable gains - Transferring a business to a company - Notes ^{4 / 4}

Incorporation Relief

Where an individual transfers their unincorporated business (sole trader business/partnership) to a company, the individual assets of the business are deemed to have been disposed of at market value to the company. 

Incorporation relief is available to allow the gains arising on incorporation to be deferred until the shares in the company are disposed of.

Conditions for the relief

All of the following conditions must be satisfied for the relief to be obtained.

When all of these conditions are met, the relief is automatic.

1. The unincorporated business is transferred as a going concern.

2. All of the assets of the business (other than cash) are transferred to a company.

3. The consideration received for the transfer of the business must be received wholly or partly in the form of shares in the company.

How to calculate incorporation relief?

If the consideration is fully in shares, then the whole capital gain is deferred by deducting it from the cost of shares, producing a lower base cost, which will be used to calculate the capital gain when the shares are disposed of.

If the consideration is only partly in shares, then the following formula is used to calculate the amount of gain deferred:

Deferred gain = Total capital gain * (M.V. of the shares received/M.V of the total consideration)

This deferred gain is deducted from the cost of the shares, to produce a lower base cost, which will be used to calculate the capital gain when the shares are disposed of.

Note:

From 6 April 2019, where an unincorporated business has been sold to a company wholly or partly in exchange for shares, and incorporation relief has been applied, the period when the individual owned the unincorporated business now counts towards the qualifying two year period.

Illustration

Jake has been a sole trader for the last 5 years and now intends to sell his business to Jake Ltd.

His business is valued at £540,000 and he will receive shares in Jake Ltd in respect of the market value. 

This will result in a chargeable gain of £160,000 in respect of the business premises and £30,000 on goodwill. 

He will sell the shares for £600,000 in 6 months. 

He is a higher rate tax payer and has used his annual exempt amount in full.

Should he allow the automatic incorporation relief to apply or should he specially elect for it not to apply?

• Solution

  With incorporation relief

  He has received the consideration fully in shares with a market value of £540,000 - therefore the entire gain can be deferred.

  Market value £540,000
  Less C. gain (£160,000 + £30,000)
  Base cost of shares £350,000

  Sale of shares

  Sale proceeds £600,000
  Less base cost of shares (£350,000)
  Chargeable gain £250,000
  CGT (£250,000 * 10%) = £25,000 (ER relief applies as he has held an interest in the business (sole trade + shares) for more than 2 years).


  Note: remember that if incorporation relief has applied on the sale of an unincorporated business to a company, the two year qualifying period on the disposal of the shares includes the period for which the individual owned the unincorporated business.

  Specially elect for Incorporation relief not to apply

  He is disposing of his entire business which he has owned for more than 2 years, therefore entrepreneurs' relief /business asset disposal relief will apply. 

  Remember that entrepreneurs' relief/business asset disposal relief will not apply for the disposal of goodwill, as this is a close company. 

  CGT for premises £160,000 * 10% = £16,000
  CGT for goodwill £30,000 * 20% = £6,000
  CGT on disposal of the sole trade £22,000

  However, in this situation, on the sale of the shares, the 2 year qualifying period would not have been met and as such Entrepreneurs’ relief/business asset disposal relief will not apply on the disposal of the shares.

  CGT on sale of shares
  Sale proceeds  £600,000

  Less base cost of shares  (£540,000)

  Chargeable gain  £60,000

  CGT (£60,000 * 20%) = £12,000
  Total CGT due if incorporation relief is disapplied £34,000 (£22,000 + £12,000)

  Conclusion

  He should not elect to disapply incorporation relief as this results in a lower payment of CGT.