Tax Implications on Incorporation of a Business and Disincorporation of a Establish Company in UK


When you are thinking to incorporate a business, then a careful planning is required focusing on the accountability of resultant liabilities of tax. Incorporating a business yields both advantages and disadvantages which will be looked at in this blog and the tax consequences after the disposal of shares will also be considered. The second part of the blog throws light on the implications of tax if the disincorporation of a company occurs.

Incorporating a Business

Advantages

Mentioned below are some of the advantages of incorporating a business:

  • It is easier to make disposal of shares in a company than interest in a business, hence there is an advantage to raise equity and make sale to outside investors.
  • Advantages for employees can be more tax efficient.
  • If the company is an ltd formation UK then the shareholders have a limited liability.
  • By making use of incorporation, the value of a business can be converted into shares those listing on a recognized stock exchange can eventually be done. This results in the ownership’s succession and hence, the original proprietors can become very wealthy.
  • In case of retaining of the profits, only incorporation tax’s payment has to be made and not that of NIC or income tax.
  • The provision of pension can be made by the ltd formation UK or the employer for employees, such as directors with no liability of national insurance.
  • It is easier to make an arrangement of financial loan as the charge on assets of the company can be taken out by the lender.
  • A partnership or a sole trader do not have as much of a respectable image as that of a company.

Disadvantages

Incorporation of a business also involves some drawbacks that are mentioned below:

  • The losses of trade are restrained to set off against corporate profits.
  • The challenging of share of profit of the partner is not done openly by the HM Revenue and Customs under the condition that the recipient is a genuine partner. On the contrary, the challenging of excessive remuneration to director or employee can be done.
  • Dates for the payment of tax for a company and its employees such as PAYE, CT and NIC are in general, well in advance of those for self-employed.
  • There can exist some statutory needs of keeping books, audit, filling accounts etc.
  • There is a potentially double charge of capital gains on assets.
  • There is no carry back of losses of trade in the opening years, i.e. no relief equivalent for the early losses of trade.
  • NIC for the employee and the employer company will, in general, exceed the contributions expected from a self-employed person.
  • Assets being used in the business but held outside the entity of business can make a qualification for 50% BPR for IHT. In case of a partnership, the owner does not necessarily need to be a partner but in the scenario of a company making use of an asset, the owner should be a controlling shareholder.
  • The requirements of disclosure of published accounts may provide information to competitors or employees that owners of business would not have disclosed willingly.

Income Tax

A trade is considered as discontinued for the purposes of tax and the cessation rules become applicable if an unincorporated trade is shifted to a register ltd company UK. There is a requirement of careful consideration of available overlap profits, level of profit and date of transfer in order to prevent oneself from large taxable profits in a year and to make use of the basic rate tax band and personal allowance in the most effective manner.

As an example, consider that a trader with a December 31st end of year makes the incorporation of his business on March 31st, 2014, then the cessation year will be 2013/14. If he earns a monthly profit of £3,000, then the taxation of his profits will be done in 2013/14 between the duration of January 1st, 2013 to March 31st, 2014 (15 months) and that will be £45,000 minus any relief for overlap. However, if the incorporation gets delayed until April 30, 2014, then the cessation year will be 2014/15. The taxation of his profits will be done on £12,000 in 2014/15 minus any relief for overlap and on 12 months of profit in 2013/14 (£36,000).

Upon the transfer of trade to register ltd company UK a balancing charge will usually occur as machinery and plant are considered as being sold out at a market rate. However, in the case where a company is under the control of a transferor, there is a connection between the two and an election may be made so that the transfer is not treated as a permanent ceasing for the purposes of capital allowances. Then the transfer of plant takes place at its value of tax written down.

The unrelieved losses of trade cannot be carried forward to a company as such, but can be set against any income that is acquired from the company by the means of dividends, remuneration and so on, under the condition that the exchange of business is done for shares and those shares are still held at the set off time of the loss. The relief for terminal loss may also be present for the loss of the preceding 12 trading months.

Capital Gains Tax

The disposal of chargeable assets is done to the company at their open market values when the transfer takes place. In this case, the liabilities of capital gains tax may occur, on buildings, goodwill and land in particular.

If the entire business or the entire business excluding cash is transferred to the company in the form of a going concern in exchange for shares in the company, any chargeable gains are rolled over through relief of incorporation automatically, lessening the base cost of the shares on a subsequent disposal. If the shares are kept until death, the liability of tax may never occur since no capital gains tax occurs on death.

Individuals who incorporate a business can make the election that incorporation relief should not be applicable. This election should usually be made within two years from January 31st following the end of year of tax in which the incorporation of business was done. Making the election could prove beneficial if the gains are quite small and relief of entrepreneurs will be applicable.

It may not be suitable for all the assets comprised in the business to be shifted to the company. As a substitute, an individual can make use of the gift relief to transfer chargeable assets of business to a company and defer any gains by subtracting them from the base costs of the assets for the company.

Value Added Tax (VAT)

The transfer of assets will not be considered as a supply for the purposes of VAT (TOGC: transfer of a going concern) if all of the conditions mentioned below are satisfied:

  • If only a portion of the business is transferred, the portion being capable of distinct operation.
  • There should be no significant breaks in the normal pattern of trading before or right after the transfer.
  • In the case of new buildings, the company makes an election to tax.
  • The company has to make use of the assets in the same type of business whether it is a part of an existing business or not, as that carried on by the transferor, the transfer of business being done as a going concern.
  • If the person who transfers the business is a taxable person, the company is a taxable person when the transfer takes place or instantly becomes one as a result of the transfer.
  • In the case of buildings and land, the company makes an election to tax if the transferor has done so.

All the other assets of the business can be transferred outside the VAT scope according to the rules of TOGC.

An application may be submitted for the company to take over the existing registration number of VAT. In this case, the company will take over all the liabilities and debt of the business but it will be able to make a claim of VAT impairment loss relief in respect of supplies made prior to the transfer.

In case if the above conditions cannot be met, VAT will be charged on the transfer, but this will only represent a problem of cash flow in most cases.

After registering a new business UK notification of the incorporation should be sent to the HM Revenue and customs within the duration of 30 days.

Stamp Duty Land Tax

The stamp duty land tax will be applicable to the transfer of land as a transfer at market value. The consideration of use of gift relief should be done so that the retaining of land can be done outside the company.

Company’s Disincorporation

If a disincorporation relief is applicable, there will be no charge of corporation tax on the transfer of buildings, land and goodwill to the shareholders by a company. Other reliefs may be applicable to the transfers of inventory, plant and machinery. A tax charge may occur for the shareholders upon the assets’ distribution, either capital gains tax or income tax.

Disincorporation is the process of a business transferring its legalized form from an establish company in UK to one operated by a self-employed individual or partnership.

The achievement of this is done by the transfer of the business in the form of a going concern, with its liabilities and assets, from the company to a single or all of the shareholders. Then the business is continued by them in their capacity as a partnership or a sole trader.

The main reason for wanting a disincorporation, can be to avoid the extra administrative and regulatory needs. Sending a corporation return of tax to HMRC is included in this. The shareholders and the directors of the company may also feel the need to complete individual returns of tax. Operating as a company may also include operating PAYE, which would not be mandatory otherwise if the business does not include any other employees.

Some individuals do not succeed to keep personal cash distinct from the business as they do not find it easy to have an understanding of the notion of the company as a legalized entity distinct from the directors or the shareholders. This may lead to underpayment or errors in their returns of tax. Under such scenario, it can be better to carry out the business in an unincorporated form.

On the contrary, the finances of the company are kept distinct from the personal finances of the directors or the shareholders who are not directly liable for the debts of the company. This happens in the case where the operation of a business is carried out through a limited company in a proper manner. The resultant loss of limited liability for the business due to disincorporation should be balanced against the simpler administration needed for an unincorporated business.

Planning of Tax for Company upon Disincorporation

  • Goodwill: Disposal by company upon transfer to shareholders. If disincorporation relief is applicable, deemed to be shifted at the lower of market price and written down value of tax so that any profit does not occur for the company. Obtained by shareholders at the value of disposal.
  • Buildings and Land: Disposal by company upon transfer to shareholders. If disincorporation relief is applicable, deemed to be shifted at the lower of market price and allowable acquisition price so that any gain does not occur for the company. Obtained by shareholders at the value of disposal.
  • Machinery and Plant: If the company and shareholders are in connection, then balancing adjustments can be avoided and an election takes place for the transfer of assets at the written down value of tax.
  • Inventory: If the company and shareholders are in connection and an election takes place, the transfer occurs at the greater of original price of the stock and the price of transfer
  • Losses: any losses unused cannot be transferred to the unincorporated business and hence, will be lost.

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