Incorporation relief helps to delay the payment of capital gain tax (CGT) that is charged on the disposal of an unincorporated business by a sole trader (or partnership) to a company in exchange for the company’s shares. The CGT payment will be delayed until the shares are disposed of or sold. If it will not be sold or disposed of, the CGT will be delayed for an indefinite time.
According to the government of the UK, to qualify for incorporation relief, one should fulfill two requirements:
- The person be in a business partnership or a sole trader
- Transfer all the assets and business in return for the company’s shares
When the business is incorporated by transfer of assets and business, the disposal of assets will be treated as disposed at market value. This might result in chargeable gains as the cost and the market value of assets would be different. If a person or partnership transfers its business based on going concern to a company in exchange for shares of that company, he might get incorporation relief.
The relief is automatically given, there is no need to claim it separately. The remaining CGT will be paid on the amount other than the gain on the disposal of those assets.
Incorporation relief is only given on the proportion of shares. Capital gain tax (CGT) will be payable on any cash received on the transfer of business.
If there is more than one owner of the transferred business, each owner or partner is entitled to separately make an election. This makes each partner independent in order to make decisions regarding the incorporation relief.
Not availing Incorporation Relief:
If someone doesn’t want to avail of incorporation relief, he can give notice to HMRC before the relevant dates. The relevant date will depend on whether the person has disposed of the shares he got in exchange for the business or not. If he has sold the shares, then the date of disposal will be important. If the shares are sold before the tax year end following the year in which the business was transferred, one should tell HMRC before 31st January of the next tax year in which the business was transferred.
If the person sold some or all the shares or retained the shares after the tax year end following the year in which the business was transferred, he should tell HMRC before 2nd anniversary of 31st January in which the business was transferred.
For Buy-to-let Properties:
There is a special requirement for buy-to-let property businesses. These businesses are required to prove that they are genuine businesses to get incorporation relief. For example, proving that those are not just passive investors but actively manage the tenants and properties.
Transfer of shares to spouse/civil partner:
If the shares are transferred to the spouse or partner with whom a person is living, it will not be considered as disposal for the election of not availing incorporation relief (elect not to apply Section 102 Taxation of Chargeable Gains Act 1992) considering that section 58(1) Taxation of Chargeable Gains 1992 applies, even if it was sold or gifted. This makes the relevant dates for election to be 2nd anniversary of 31st January of the year in which the business was transferred. In case of disposal of the shares by spouse to any person other than you, then it will be considered as disposal made by the first person and that disposal date will be used to decide the relevant dates for election.