Until the 3rd December 2014 individuals trading as sole traders or partnerships were allowed a significant tax incentive on incorporation. Goodwill created by the individual could be sold at market value to their new company and the capital gain made by the individual would be taxed at 10% entrepreneurs’ relief. The added bonus was that if the unincorporated business started after April 2002 this goodwill could be amortised in the company and would receive corporation tax relief in line with the accounting treatment! In effect tax was paid at 10% by the individual and then tax relief was claimed at 20% by the company.
In the autumn statement it was announced that these rules will be changed. The legislation has been amended to remove the ability to do this. Now any capital gains on goodwill sold to a close and connected company will be taxed at the standard CGT rate 18%/28%. The subsequent amortisation will no longer receive tax relief. Teamed with this new accounting standards will make it necessary to write the goodwill down over its useful economic life, so the accounting and the tax treatment will differ.
There are then two options with regards to the goodwill present at the date of incorporation.
1/ If it is separable from the trade then it can be retained by the individual and used by the company. With a subsequent disposal of the company and the trade it may be possible to tax any gain on this personal goodwill at 10% Entrepreneurs Relief.
2/ The goodwill can still be transferred to the company. As the parties are connected this transaction will be at open market value. The gain would be taxed at the normal capital gains rates 18/28% and a Directors Loan Account credit would be created. If there is no appetite or ability to pay the capital gains tax then the owner may wish to claim gift relief to hold over the gain until a subsequent disposal.
The pre December 2014 rules gave more incentives to incorporation and the change of rules will remove the benefit for some individuals. However incorporation is still a very attractive opportunity for many individuals or partnerships especially if there is borrowing to be repaid.
If you would like to discuss the potential benefits of incorporation then please contact Peter for an appointment.