Mark McLaughlin outlines a lesser-known tax relief when an unincorporated business is transferred to a limited company upon incorporation.
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When an unincorporated business is transferred to a company upon incorporation, this results in a cessation by the business owner (i.e., the sole trader, or partnership).
If a trade was loss-making immediately prior to incorporation, the normal rules allowing for trading losses to be carried forward against future profits of the same trade (ITA 2007, s 83) cease to apply, because the trade is no longer carried on by the sole trader or partnership (i.e., the company is a separate legal entity). Hence, unless the loss can be used in some other way (e.g., ‘sideways’ relief against other income), the loss is stranded and cannot be utilised.
To the rescue…
However, all is not necessarily lost (pun intended!).
A specific (but not very well-known) form of carry-forward income tax loss relief is available on the incorporation of a business, if certain conditions are satisfied (see ITA 2007, s 86). Those conditions are paraphrased below.
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The trade is carried on by an individual, or by a partnership of individuals.
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The trade is transferred to a company, which is carrying on the same trade.
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The consideration for the transfer is wholly or mainly the allotment of shares to the individuals.
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The total income of such individuals for a relevant tax year includes income they derived from the company.
A ‘relevant year’ is broadly one throughout which (or from the date of transfer to the following 5 April) the individual beneficially owns the shares, and the company carries on the trade.
Strictly speaking, relief is not available for a tax year unless the individual retained all the allocated shares. However, HMRC considers that relief should not be refused so long as the individual keeps shares which represent more than 80% of the consideration received for the business (see HMRC’s Business Income Manual at BIM85060).
The ‘small print’
The relief conditions need to be considered carefully. For example, if the company pays for the business in cash and shares, care will be needed to ensure compliance with the condition in the third bullet point above.
However, in HMRC’s view, if the incorporation agreement states that the consideration is in cash, but the whole amount is subscribed for shares in the company, the shares may be regarded as the consideration for relief purposes.
If the relief applies, income derived from the company (e.g., remuneration, dividends, interest) is treated as trading profits carried on by the individual or partnership of the relevant tax year (NB There is no corresponding relief for National Insurance contributions (NICs) purposes).
Example: Loss relief on transfer of business to company
Joe is a sole trader. Trading in recent years was difficult, and he has brought forward trading losses of £60,000. However, the business has now become profitable again. Joe decides to incorporate. He transfers his business to a company in return for ordinary shares worth £100,000, and a director’s loan account credit balance of £20,000.
The company carries on the trade profitably, and Joe receives director’s remuneration of £30,000 for the next two years. The trading losses may be set against his remuneration from the company (although NICs are still payable on his salary).
Practical tip
A claim for loss relief where the trade is transferred to a company must be made within four years from the end of the tax year to which the claim relates (TMA 1970, s 43(1); see BIM85075).
