The transfer of chargeable assets from an unincorporated business to a company is a disposal for CGT purposes.
Further, the transfer is normally a disposal between connected persons. Where this is the case, the rules of TCGA 1992, s 18 prevail; in particular, the transaction is to be treated as a bargain not made at arm’s length. This in turn brings TCGA 1992, s 17 into play, with the result that the chargeable assets of a business are treated as passing at market value (all references in this article are to TCGA 1992).
How the relief works
If there were to be a large chargeable gain, with tax payable, this would amount to a significant disincentive to incorporation. However, a specific relief from CGT upon incorporation (under s 162) potentially applies automatically, if the following conditions are satisfied:
- a person who is not a company (ie a sole trader or individual partner) transfers to a company a business as a going concern;
- together with the whole assets of the business, possibly excluding cash; and
- the business is so transferred wholly or partly in exchange for shares issued by the company to the person transferring the business.
This ‘roll-over relief on transfer of business’ broadly provides (in s 162(2)) that on the transfer of the business, the cost of the new assets (ie the company shares) shall be deducted from the chargeable gain. Correspondingly, s 162(3) gives the base cost of the new assets as reduced by the amount left out of the CGT computation on incorporation.
Whilst the relief seems straightforward enough on the face of it, there are potential traps for the unwary, a selection of which are outlined below.
1. Which assets?
Incorporation relief under s 162 is very specific. All the assets of the business (apart from cash which is, of course, not a chargeable asset) must be transferred to the company and this must be done wholly or partly in exchange for shares.
In fact, cash is not the only item which may be left out. HMRC’s Extra-Statutory Concession D32 states that relief under s 162 is not precluded by the fact that some or all the liabilities of the business are not taken over by the company.
However, care is needed to ensure that liabilities remain within the terms of Concession D32. For example, if the company raises finance and uses the funds to pay the proprietors for the business to enable existing borrowings to be repaid, this will constitute (non-share) consideration for the business, resulting in any s 162 relief being restricted.
2. All assets (except cash)?
A major asset retained from the business (commonly property) prejudices the application of s 162. What about a minor one, though?
It is not unusual that a business proprietor would wish to retain personal ownership of a private car outside the company. Although used in the business, it may not have been on the balance sheet. However, it is not difficult to envisage HMRC using this as a reason to deny s 162 relief. Positive steps ought to be taken to withdraw the car from the business before incorporation so that it has ceased to be an asset of the business before the time of transfer. Certainly, it ought not to be simply withheld.
It may be necessary to remove and retain part of the pre-incorporation capital account, for example to meet the tax liabilities of the unincorporated business. Provided that the final accounts of the unincorporated business have made full provision for outstanding tax liabilities, this should not be a problem.
3. Cash consideration
Occasionally, other consideration might be taken in addition to shares. This could be in the form of loan stock issued by the company, or more simply the creation of a director’s loan account with a credit balance. In these circumstances, the gain which may be rolled over is limited to the following (s 162(4)):
A/B of the amount of the gain on the old assets where:
- A is the cost of the new assets (shares); and
- B is the value of the whole consideration received by the transferor in exchange for the business.
If the consideration for the business includes amounts left owing to the transferor as sums credited to a loan or current account with the company, HMRC’s approach is to treat the amount of the loan or current account as consideration other than shares (see HMRC’s Capital Gains manual at CG65720 and CG65760).
The proportion of gains upon incorporation which is attributable to the loan or current account becomes chargeable in the tax year of disposal.
4. Not fully covered
Do not assume that the gain will always be fully relieved. The business must be transferred as a going concern and must therefore reflect liabilities to be satisfied by the company. An undertaking to satisfy these liabilities amounts to further consideration, but Concession D32 prevents the assumption of liabilities from being treated as consideration for the purposes of the s 162 computation.
However, this does not mean that the liabilities can be ignored in determining the market value of the assets transferred.
Where the liabilities are relatively high (and are being transferred), the net asset value of the business (which equals the value of the shares issued) may be low. If the chargeable assets have large inherent capital gains (watch out for goodwill off the balance sheet) it may be impossible to roll over all the gain; the base cost of the shares cannot go below zero.
So, a situation can arise where all the assets are transferred, only shares are issued, and yet a chargeable gain still arises.
5. Breaking the conditions
CGT relief for gifts of business assets under s 165 is often used as an alternative to incorporation relief under s 162. However, as indicated above, relief under s 162 is mandatory if the relevant conditions are satisfied.
If gift relief under s 165 is preferred, it will necessary to ensure that the requirements for incorporation relief are broken (eg by retaining some non-cash assets outside the company).
The above points are only a selection of possible issues surrounding s 162 relief. Detailed consideration of the relief, and any possible alternatives, should be considered well in advance of the incorporation of the business.
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