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Incorporating sole trader - CGT, CA & VAT impacts

Help! I'm urgently looking to incorporate my side business & need to check the key tax implications.

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I'm urgently planning to incorporate my side business (I've left it a bit late) and I'm trying to get my knowledge up to speed before I engage an accountant and possibly a tax advisor. I like to make sure I understand the key considerations in detail and have gone through numerous posts and webpages before posting.

I have an online business which has a small amount of fixed assets (<£5k) and almost nothing else on balance sheet (trivial debtors/creditors) other than cash so the main item to be transferred on incorporation is goodwill. I have no property (so no SDLT issue), no stock and I'm not worried about IHT. The tax implications I've considered:

- CGT: I expect to transfer all assets and liabilities (except cash) across to the new company in exchange for shares so incorporation relief should apply automatically deferring any CGT on transfer. The only capital gain on transfer arises from goodwill, so I can't see any significant tax planning opportunity using BADR and loan accounts. I also don't see any benefit from using holdover relief instead of incorporation relief since I'm able to transfer all assets and have no property. Are there any common negative implications in the future from using incorporation relief? I'm aware the value transferred will be "locked" into share capital (see valuation point below), so guessing that there could be CGT when I wanted to sell the shares or close the company but is there anything else?

- Capital allowances: I will be transferring a small amount (<£5k) of fixed assets at £1 disposal value to crystalise a balancing charge, since otherwise I won't be able to claim AIA in the final year of trading as a sole trader. This seems easier than creating a new accounting period. Based on CAA 2001, I think 62(2) and 62(3) is pretty clear that for connected parties the disposal value is limited to at most qualifying expenditure but is not deemed at market value so I think I just agree that £1 of the transferred amount related to the disposal value of the fixed assets. Am I correct? If so, would the fixed assets also be accounted for at £1 at cost in the accounts?

- VAT: The business will transfer as going concern so no VAT chargeable on assets and goodwill transferred. Do I need to inform HMRC or complete a form on this? Also, I'll complete Form VAT 68 to transfer VAT registration number of sole trader business to the new company. Anything else to consider?

- Extraction of profits: I won't be touching the retained earnings for some time as will wait until I retire and then extract any profits after tax made in the company at lower tax rates.

- Accounting for the valuation of business transfer: I understand that when using incorporation relief, the share capital will be equal to the value of the business. Of course, I'll be looking to get a proper valuation report to determine this but will any external party actually care/query? There is no tax at stake at this point due to incorporation relief so if I used a rough valuation who would actually question this?

Really appreciate any info you could give, thanks!

Replies (31)

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By WhichTyler
12th Aug 2020 11:50

Your name suggests you are an accountant, but the fact you are looking to engage one suggests otherwise?

If this is urgent, it would be better to engage the accountant/TA asap and put these points to them, as you are going to have to do this anyway, rather than spend time waiting for answers here, I would suggest...

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Replying to WhichTyler:
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By Kevin Kavanagh
12th Aug 2020 11:53

Just beat me to it!

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Replying to WhichTyler:
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By Kevin Kavanagh
12th Aug 2020 11:53

Just beat me to it!

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Replying to WhichTyler:
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By ConfusedTaxAccountant
12th Aug 2020 12:16

I'm an inhouse tax accountant but not experienced with small business issues (particularly regarding incorporating sole trader business) so was looking to potentially engage one.

My wife is also an accountant so we were hoping that we might be able to work this out between us but wanted to manage the risks and don't think it's currently possible. I was hoping these issues were common but appreciate I was asking a lot!

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By andrew1211
12th Aug 2020 11:53

Rather too much to digest and advise on using a forum.....

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By Tax Dragon
12th Aug 2020 12:02

I agree with WT. So does Sift, if you read the https://www.accountingweb.co.uk/terms-and-conditions-of-use

"No reliance on information

"The content on our site is provided for general information only. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content on our site."

That includes what you read in this forum. (It's sensible advice too for whatever you find online.)

Some of what you say is correct - you've done some good research since your last question, well done - some of it is still wrong.

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Replying to Tax Dragon:
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By ConfusedTaxAccountant
12th Aug 2020 12:15

Thanks very much. I think I've reached the point of my own self-research so will start a search for an accountant/tax advisor based on this. It has been really interesting seeing how the reliefs have really decreased over the past 5 years when incorporating your business! ER on goodwill, stopping deduction of amortisation of goodwill, reducing tax-free dividends... quite a change!

If it would be possible (no worries if not), could you just mention the particular points I put that were wrong? No problem if you prefer not to.

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Replying to ConfusedTaxAccountant:
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By Tax Dragon
12th Aug 2020 12:43

ConfusedTaxAccountant wrote:

No problem if you prefer not to.

It's not that so much as that I don't want to provide you with an incomplete statement that'd be open to misinterpretation.

Also, I appreciate you have put a lot of effort into your OP; you are deserving of a more thoughtful/thorough reply than I have time to provide. (And, taking a step back, I am not(*) convinced that incorporating is your best option, taxwise; it may be, but getting involved in a detailed discussion with you regarding the tax consequences of so doing bypasses the question of whether you should do it at all - and the sort of issues that a good advisor would talk through with you.)

(*) I wasn't, anyway, based on your two OPs; now you have mentioned an accountant wife, it could be different. It's changed my presumptions. Do you mind if I ask a question back at you: when you take up your nomadic life, will she be doing the same? [Actually.... no, don't answer. That makes it sound like I want to advise you in here. I don't. Beyond the obvious: be sensible, take advice.]

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Replying to Tax Dragon:
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By ConfusedTaxAccountant
12th Aug 2020 12:47

I haven't asked her yet! Just kidding, yes we're keen to try doing together at some point.

Appreciate your reply and what you're saying makes total sense and depends on the facts. Thanks again.

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JCACE
By jcace
12th Aug 2020 14:37

Just out of interest, and to put things into context, given the value of fixed assets is under £5K, what value do you put on the goodwill, and is that an arms length value?

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Replying to jcace:
paddle steamer
By DJKL
12th Aug 2020 14:49

Spot on- is incorporation relief even needed here, would firing in any net assets against directors' loan credits be more efficient?

An indication of profit level and how many hours likely unpaid work it takes to generate said profits might make two CGT allowances more than enough to mop up any gain on any goodwill.

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Replying to DJKL:
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By Paul Crowley
12th Aug 2020 15:31

My opinion evertime, The small CGT now gives tax free drawings straightaway and no double charge of Corp tax and Exit tax on any sale of goodwill up to value realised now.

If it is not sellable goodwill, does it really exist?

Advice I push onto everybody is: know the exit plan before entering.

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Replying to Paul Crowley:
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By ConfusedTaxAccountant
12th Aug 2020 16:12

Could you provide a little more info on the potential double tax that could arise in some situations? This is the sort of thing that worries me, which is why I'll be getting advice but useful for awareness.

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Replying to ConfusedTaxAccountant:
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By Paul Crowley
12th Aug 2020 16:40

Depends what is sold, company shares or business assets by company.
Company shares: not worth as much as the assets, discounted for risks and latent tax liabilities.
Assets by company: profits on sale of goodwill taxed with only indexation allowed.
Net of tax profits either dividend distributions or members voluntary liquidation to get BADR.

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Replying to DJKL:
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By ConfusedTaxAccountant
12th Aug 2020 15:57

The company doesn't have a significant track record. It only started last year and made ~£30k profit last year, £70k+ profit in last 12 months and hoping for ~£100k depending on Dec/Jan performance. Probably 20 hours a week unpaid work. How does the unpaid work impact this?

Interesting, how would you use both of the CGT allowances on incorporation? I assumed I could only use mine.

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Replying to ConfusedTaxAccountant:
ALISK
By atleastisoundknowledgable...
12th Aug 2020 22:35

ConfusedTaxAccountant wrote:

Interesting, how would you use both of the CGT allowances on incorporation? I assumed I could only use mine.

Transfer to a partnership (you & your wife), incorporate the partnership. 2 x CGT allowances.

You mention somewhere a valuation of £20k. Via the partnership route, this is covered under the above with no tax. Company owes you (plural) £20k with no personal tax liability. Of course, your wife will have to report some partnership income for a short period of time, say 06/04/20 - present.

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Replying to atleastisoundknowledgable...:
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By Tax Dragon
13th Aug 2020 10:55

I'll give you the benefit of the doubt there atlea and assume that was either a typo or that you are pointing out the missed benefits of planning early (instead of undertaking the "urgent planning" mentioned in the OP) - though it seems a bit mean to be pointing out "this is what you could have done"! While it may be a salutary lesson, I didn't think you were like that - and there may still be time to do things (if things need doing)… if only we'd all stop harassing the OP with ideas and let him do the sensible thing: go and take advice.

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Replying to jcace:
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By ConfusedTaxAccountant
12th Aug 2020 15:31

The company doesn't have a significant track record (only started last year and made ~£30k profit last year and now expecting £70k+ profit this year and hoping for ~£100k depending on Dec/Jan performance). Due to the short period so far, not really sure how to value it so I'm planning to pay for a valuation exercise when requesting incorporation advice.

If the goodwill coudl be argued to be low (e.g. <£30k) would this generally push you more towards upfront CGT with loan account and if it is large does this push more towards incorporation relief? I appreciate it is more complex than this but useful to get an idea of what is considered.

[I will be taking advice but I do find this useful/interesting to be aware in my discussions so really appreciate the comments]

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Replying to ConfusedTaxAccountant:
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By Paul Crowley
12th Aug 2020 15:37

Dragon's Den discussions on high current goodwill value based on future rather than current real activity usually end up with disappointed entrepreneurs
If you run the business for free, consider the value of your time.

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Replying to Paul Crowley:
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By ConfusedTaxAccountant
12th Aug 2020 16:03

My previous message wasn't clear but the £70k was profits in the last 12 months and £100k is extrapolating from the last couple of months performance compared to last year (3x last year's). Both are current activity but hard to know for sure and of course more competition at some point but hopefully we will have progressed but then.

If the valuation was only £20k after taking into account unpaid work, would that be something that pushes more towards CGT upfront with DLA?

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Replying to ConfusedTaxAccountant:
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By Paul Crowley
12th Aug 2020 16:47

CGT tax is only 20% at higher rate, No BADR
Equals tax at basic rate to get tax free loan in comany for the full value before deducting CGT allowance.
And a base cost should it ever be sold by company.

I go with CGT everytime, never used incorpoation relief and probably never will
Why lock value into shares?

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Replying to Paul Crowley:
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By Tax Dragon
12th Aug 2020 18:03

As Wilson has pointed out elsewhere, it's not "tax free loan in company". At least, not totally tax-free - company can repay the loan only out of after-tax profit.

More generally, IMHO, the one-size-fits-all answer you suggest doesn't begin to fit all. Bump the fixed assets up to a million and the goodwill to 250k and see what you think. (Having said that, we are about to incorporate a business of that size and the client has chosen not to go down the 162 route. There are some interesting and non-obvious downsides to not doing so (and some more obvious ones, like the immediate five-figure tax hit), but still the ups are seen as more valuable... oh, wait, am I arguing against myself now?! Hm!)

Paul Crowley wrote:

Why lock value into shares?

10% deferred is less than half of 20% up front?

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Replying to Tax Dragon:
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By Paul Crowley
13th Aug 2020 09:43

Allways discuss with client long term view and expect client to make the decision.
Most recently with a specific client that took advice elsewhere, £5,000, on how to not pay tax now. They answered that but did not look at alternatives.
Eventual decision was was not to ignore the advice, simply not to take the action they suggested that answered her specific question, and just that question. She was a bit annoyed that other party did not look at the alternatives.

Clients should be advised of all options. Then they decide.

If a client picks defer it is their choice and I would follow instructions

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Replying to Tax Dragon:
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By Tax Dragon
13th Aug 2020 10:42

Tax Dragon wrote:

oh, wait, am I arguing against myself now?! Hm!)

@TD... No, idiot, that was your point!

@others... It's come back to me (sorry, the heat yesterday did for my ability to hold an entire thought in my head)… my point was that previous experience of incorporating businesses of the size I mentioned would suggest that route 162 might be expected to be the preferred road, but factors specific to the industry in my current case mean that an alternative road is preferred. One size indeed does not fit all.

(In the OP's case, as I said before, is sounds like there are some unusual factors and I still wonder whether incorporation is the best plan at all.)

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Replying to ConfusedTaxAccountant:
paddle steamer
By DJKL
12th Aug 2020 15:51

To calculate goodwill you have to normalise profits, that means amongst other things how much would you need to pay someone else to run/manage that business? This is not 20hours x NMW, with the greatest respect a NMW member of staff likely cannot run it, say supervise accounts, agree contracts, everything, even a manager would need supervised.

So take the profit , reduce by wages that would need to be paid, NIER, pension contributions etc, calculate profits, take away notional 19% C Tax.

What multiple to apply depends on lots of things, how easy to scale, growth prospects, but likely 4-5 times post tax adjusted profits at best.

Goodwill within a ST is generally a lot less than most people think it ought to be, they ignore the own labour/own management element.

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Replying to DJKL:
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By ConfusedTaxAccountant
12th Aug 2020 16:05

Thank you, that's really helpful.

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By Southwestbeancounter
12th Aug 2020 15:11

I haven't got the time to look at your query in depth but one thing I spotted was that you said;
'Capital allowances: I will be transferring a small amount (<£5k) of fixed assets at £1 disposal value to crystalise a balancing charge, since otherwise I won't be able to claim AIA in the final year of trading as a sole trader'

Not 100% certain what you mean but I'm sure you still aren't able to claim AIA in your final year of trading in any event but I might be wrong.

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Replying to Southwestbeancounter:
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By ConfusedTaxAccountant
12th Aug 2020 15:55

My wording was incorrect (remove "otherwise"). I believe the £1 disposal value will give a balancing allowance which is deductible in the final year so not reliant on the AIA.

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Replying to ConfusedTaxAccountant:
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By Tax Dragon
13th Aug 2020 10:58

That's not right, BTW. But it (and indeed the CGT points) are pennies compared with what I think you are at risk of losing, if some of my presumptions are right.

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