Time to Disincorporate? Pros and Cons

 Joe Brough looks at the relative tax positions for companies and unincorporated businesses and the tax implications of disincorporation. 

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As the tax benefits of trading via a limited company have been gradually whittled away, and in view of the additional administrative costs, business owners may be considering whether disincorporating is the right decision for them. 

The basic tax position 

The starting point for any disincorporation decision will usually involve a comparison of the tax liability when operating as a company against the equivalent position of being a sole trader.  

For example, if profits totalling £50,000 are fully extracted by a one-director company, after allowing for a salary equivalent to the personal allowance, more income will be retained if they were trading as a sole trader.  

Illustration: 2025/26 

However, this comparison does not tell the full story, as there will be other factors to consider in each case, so each decision must be reviewed based on its individual circumstances. 

After considering the options available, if disincorporation is still the favoured approach, there are other tax consequences to be considered and planned for, as well as actions to take where they can be avoided or mitigated.  

Capital allowances 

Disincorporation will bring about the end of a chargeable accounting period. In the final period, writing-down allowances, first-year allowances and the annual investment allowance cannot be claimed. Instead, a disposal value is brought into account, which for connected transactions is deemed to be equal to the market value of the assets disposed of and deducted from the capital allowance pool value.  

This will crystalise either a balancing charge or allowance. Whilst a balancing allowance would result in a reduction of profits or create a loss, a balancing charge will do the opposite and thus may result in creating or increasing a corporation tax charge on cessation.  

Where there is a business succession between connected parties, a balancing charge or allowance can be avoided by making an election under CAA 2001, s 266. The effect of this election is for any actual or deemed disposal proceeds to be ignored and for the capital allowance pool to be transferred at its tax written-down value.  

For an election to be valid, it must be made jointly by the transferor and transferee within two years of the date of succession. The succeeding business will then include the transferor’s closing tax written-down value as an addition in its opening capital allowance pool. 

VAT – Transfer of a going concern 

On disincorporation, if the company is VAT-registered, the ‘transfer of a going concern’ (TOGC) rules need to be considered. Where the qualifying criteria for a TOGC in The Value Added Tax (Special Provisions) Order 1995 are met, and both businesses are a ‘taxable person’, application of the TOGC rules is mandatory, with the effect that no VAT is chargeable on transferred stock and assets. 

A taxable person is a business which is, or is required to be, VAT-registered. The succeeding business may not meet this definition, either because it qualifies for an exception to registration using the ‘look forward’ test or does not meet the requirement for compulsory registration as the company’s taxable turnover for the previous twelve months was below the VAT registration threshold.  

In either case, if as a result of the transfer, the succeeding business is not (nor required to be) VAT-registered, the TOGC rules will not apply.  

Where the TOGC rules do not apply, output VAT is chargeable on the disposal of assets from the company in the normal way. Therefore, whilst the possibility of de-registering for VAT post disincorporation might be beneficial for some businesses, this should be planned for where a VAT charge will crystallise.  

Opted land and buildings 

The TOGC rules do not automatically apply to land and buildings (e.g., in London) which have an option to tax or for commercial properties which are less than three years old. A disposal of these assets on disincorporation will remain subject to VAT at the standard rate unless the buyer makes their own valid option to tax election, and notifies the seller that the option will not be disapplied prior to the transfer.  

Whilst a VAT charge on disincorporation may not be a problem where full input VAT can be claimed by the buyer, it will increase any stamp duty land tax payable, which is calculated on the VAT-inclusive price. 

Where an option to tax election has been made by the buyer and the TOGC provisions apply, the buyer will inherit any further adjustments required under the ‘capital goods scheme’. The capital goods scheme broadly applies where a building is purchased or constructed with a VAT-exclusive value of £250,000 or more. 

Therefore, where the taxable use of the building decreases post-disincorporation and within the ten-year clawback period, the buyer will have to repay a proportion of the input VAT claimed on the original purchase, despite the fact that the VAT claim was not made by them.  

Capital assets 

Where capital assets are owned by the company (e.g., land, buildings and goodwill) on disincorporation, whether these are sold to the owners or otherwise disposed of, a chargeable gain will arise as if full market value had been received by virtue of TCGA 1992, s 18. Where a chargeable gain is made, this will trigger a corporation tax charge.  

Unlike for assets subject to capital allowances, there are no reliefs available to hold over any gains. In addition, where the purchase of the asset was itself subject to a rollover relief claim, this will reduce the taxable base cost of the asset and result in an increased chargeable gain on disposal. 

For chargeable assets and pre-31 March 2002 goodwill, indexation allowance is available from the date of purchase up to December 2017 to reduce the chargeable gain, although there are limits to this relief as indexation cannot create or increase a loss on disposal.  

Post 1 April 2002, goodwill is treated differently, with any credit on disposal taxed as business income, with no indexation allowable on the cost. As a further consideration, the ‘new’ goodwill may already have received corporation tax relief where it has been expensed in the company accounts, which will reduce the allowable cost and increase the chargeable gain on disposal. 

Implications for shareholders 

Once the company’s assets have been sold or distributed, the shareholders will still need to extract any remaining reserves prior to closing the company down. If the reserves are withdrawn as dividends, the shareholders will incur an income tax charge at their marginal rate of tax.  

If the company is liquidated, however, subject to the anti-phoenix legislation within ITTOIA 2005 s 396b, the shareholders will pay capital taxes on the distributions.  

For higher-rate and additional-rate taxpayers, capital treatment will be preferable to a dividend due to the lower tax rates applicable to capital gains. However, for basic-rate taxpayers, it may be preferable to receive dividends taxed at the basic rate of 8.75% rather than a capital distribution, which, even with business asset disposal relief available, attracts a minimum capital gains tax charge of 14%. 

Where reserves are £25,000 or less, the company can be liquidated relatively simply via a voluntary strike-off procedure. If reserves are in excess of £25,000, for capital treatment to apply, a liquidator would have to be appointed to close down the company which will increase the cost of disincorporation. 

Practical tip 

On disincorporation, it is not just tax liabilities on trading profits which need to be considered, with potential tax charges arising on the disposal of capital assets, which need to be planned for and, where possible, mitigated.