Get out of jail card but only for the few
There can be a number of reasons why, for some of your clients, the business corporate wrapper does not work for them. The most common examples are small businesses that incorporated in the early to mid – 2000's when corporation tax was 0% but only found themselves trapped when the Government abolished the zero rate because companies were taking advantage of it.
Others may wish to abandon their corporate structure because of the additional administrative and regulatory requirements that are now imposed on limited companies.
The problem with disincorporation however is that there are associated tax charges which can act as a disincentive, ie:
Corporation tax due on gains following a disposal of assets.
Income tax payable by the shareholders on income distributions from the company.
Capital gains tax payable by the shareholders on any capital distributions that exceed the Annual Exemption.
Balancing charges arising from the transfer of assets.
Which is why the Government introduced Disincorporation Relief from 1st April 2013 so that businesses are not penalised just for changing their legal form.
Borne out of the Office of Tax Simplifications' (OTS) recommendations, the relief will run for five years until 31st March 2018.
Disincorporation relief allows the shareholders of a company to continue the company's business but in an unincorporated form and without incurring an immediate corporation tax charge.
The business can be transferred to individuals who are in partnership but it does not extend to members of an LLP (Limited Liability Partnership).
Research by the OTS indicated that around 91,000 of the 610,000 companies potentially eligible to use this relief might take it up.
How it works
As transfers of assets between a company and its shareholders are normally transfers between connected persons or related parties, the transfers take place at a market value basis, ie the transfer is taxed on the market value of the asset regardless of what is paid for it. This can result in the company having to pay corporation tax where the asset is worth more than its original cost or its value of tax written down.
A claim to Disincorporation Relief allows qualifying assets to be transferred below their market value so that no corporation tax becomes payable. However, as the shareholders accept the reduced transfer value as being the cost to be set against any future sale proceeds thereby increasing their gain for capital gains tax purposes, the tax charge is deferred.
Who can claim Disincorporation Relief?
A company and its shareholders can claim the relief if:
the company transfers its business to some or all of its shareholders
the transfer is a 'qualifying transfer'
the transfer takes place between 1st April 2013 - 31st March 2018.
What is a qualifying transfer?
To be a 'qualifying transfer', all of the following conditions must be present:
the business must be transferred as a going concern
the business must be transferred together will all its assets or with all the assets of the business excluding cash
the total market value of the qualifying assets at the time of the transfer must not exceed £100,000
the shareholders to whom the business is transferred to must be individuals
those shareholders must have held shares in the company throughout the 12 months prior to the transfer
This is where Disincorporation Relief becomes restrictive and ineffective for the majority of freelancers because qualifying assets are interest in land (other than land held as trading stock) and goodwill. It would be fair to suggest that for most PSCs, their balance sheets will consist of assets other than land and goodwill thereby making this relief a non-starter for contractors.
Plant and machinery and trading stock are excluded from the relief and instead separate elections will have to be made to transfer the plant and machinery at tax written down value and trading stock at original cost or other agreed price if this is lower than market value.
Making a claim
For those of your company clients that possess ‘qualifying assets’ and wish to disincorporate, then a claim must be made jointly by the company and all the shareholders to whom the business is being transferred. The transfer must also be made within 2 years of the business transfer date.
Please note that once a claim is made, it cannot be revoked.
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