Jennifer Adams considers whether ‘disincorporation’ is something that company owners should be contemplating in view of the new dividend tax rules from April 2016 and the tax implications should the company decide to go down this route.
‘Disincorporation’ is broadly the process of a company changing its legal form to a sole trader or partnership. Due to the new dividend tax regime from 6 April 2016 (which will increase the tax cost of dividends in many cases), some company owners may be wondering whether it remains beneficial to continue operating as a company, or whether it will be more tax-efficient to operate as a sole trader or partnership. The personal tax liabilities of the director/shareholder will generally increase for those who have previously taken the minimum salary and the remainder of profits in the form of dividends, whereas the self-employed will see little change (depending upon future National Insurance contributions rises).
Practicalities of disincorporation
It is easier for a sole trader or partnership to incorporate than for a company to disincorporate, as the latter process involves the transfer of the business as a going concern, including assets and liabilities, from the company to its shareholders.
The specific disincorporation issues which need to be addressed include:
- capital gains - not least by virtue of any ‘held over’ gains arising on the incorporation of the business;
- corporation tax on cessation of the company’s trade;
- trading losses;
- VAT (e.g. transfer of registration);
- what to do with the company itself – Liquidation, striking off or dormancy; and
- shareholders’ tax position on distributions from the company.
Capital gains tax
A significant problem area is the treatment of capital gains, because there will normally be a capital disposal of the company's chargeable assets, deemed to be at market value (in accordance with TCGA 1992, s 17 or s 18). TCGA 1992, s 165 ‘hold over’ relief may also be in point, should assets only have been transferred to the company at the time of incorporation. Such gains are more likely to arise in relation to assets such as land and premises.
Disincorporation relief - for ‘small’ companies
There is currently help in the form of a temporary relief for small companies, which is designed to remove certain capital gains tax charges. Disincorporation relief was introduced in Finance Act 2013 (inserted as TCGA 1992, s 162B) and refers to the transfer of assets between the company and its shareholders.
The relief is a form of roll-over relief, whereby the company is permitted to transfer qualifying assets to shareholders at a reduced value, thus no profit or gain is included in the corporation tax computation, provided that specific conditions are satisfied:
- the business must be transferred as a going concern;
- all of the company’s assets must be transferred (cash can remain);
- the market value of land and goodwill included in the transfer must not exceed £100,000; and
- the transfer is made to shareholders who are individuals and who have held shares in the company for 12 months prior to the transfer.
Additional points
- Once a claim has been made, it cannot be undone.
- Joint claims made by the company and its shareholders must be made to HM Revenue and Customs within two years of the date of the transfer.
- Shareholders to whom the assets are transferred will inherit the transfer value and they must use this transfer value in any subsequent capital gains tax transactions.
- The relief defers the tax charge on assets transferred until the unincorporated business is sold.
- Here are no conditions as to how long the company needs to have been in existence.
Calculation of asset value
Land, property and goodwill
The effect of this relief means that the transfer value of the asset will be deemed to be the lower of following:
- tax written down or market value: if the company’s goodwill arose pre 1 April 2002 and was written down under the intangibles regime and tax relief claimed (TCGA 1992, s 162B);
- cost or market value: if goodwill arose post 1 April 2002 and was included in the company’s balance sheet but no write down has been recognised for tax under the intangibles regime (CTA 2009, s 849A); or
- nil if goodwill has not been recognised in the company’s balance sheet (TCGA 1992, s 162C).
Other assets
Any other assets, such as plant, stock or debtors are not qualifying business assets for the purposes of this relief and so the value of these needs to be determined on transfer.
Other issues
Corporation tax - cessation of trade:
- unless at the end of the accounting period, cessation will be at the date of disincorporation; this will bring forward the date of payment of any corporation tax due;
- when calculating the final corporation tax liability, adjustments will need to be made for consideration of the price at which stock could be sold;
- the deemed disposal of plant and machinery will normally result in a balancing adjustment for capital allowances purposes and
- should any chargeable assets be sold, this could produce a capital gain subject to corporation tax. If sold post-cessation of trade any losses brought forward cannot be offset.
Corporation tax - trading losses
Trading losses for the final accounting period can only be offset against profits of the same period (CTA 2010, s 37(3)(a)) with any remaining carried back and set against the previous three years’ total profits (CTA 2010, s 39(2)). Any remaining losses are wasted as they cannot be carried forward as there is no company continuing to trade. The losses also cannot be transferred to the new successor business.
Value added tax
Should the company be VAT registered at cessation and the successor was previously a shareholder, the transfer of a going concern rules generally prevent a VAT charge. The VAT registration can be carried over to the new business.
Liquidation, striking off or dormancy
If the company is solvent then the members can apply for the company to be liquidated, although this can be expensive as a licensed insolvency practitioner must be involved. Such a practitioner will realise any remaining assets of the company, pay all liabilities and return any surplus to the shareholders.
A more straightforward and less costly method is to apply for the company to be ‘struck off’ under Companies Act 2006, s 1003. The company completes an online form (DS01), but there are stringent conditions that need to be complied with before the company can be no more - not least that the company has not traded in the previous three months.
Shareholders position - extracting cash from the company
Disincorporation relief applies only to the company and not the shareholders. As such there will generally be a tax charge for the shareholders on distribution of any company assets, which includes cash. If the amount distributed is small then payment of a dividend is preferable, especially if no higher rate tax is chargeable. Distributions are usually taxable as income, whereas payments to shareholders under a formal winding up are not, being taxed as a CGT disposal of an interest in shares (TCGA 1992, s 122). However, CTA 2010, s 1030A permits assets distributed on a ‘striking off’ to be deemed capital up, to a maximum of £25,000. Distributions less than this amount are charged to CGT (and potentially covered by entrepreneur’s relief); any amount in excess is charged to income tax on the whole amount.
Therefore, companies that have higher than the limit in assets, but wish to have the distributions treated as capital, must go down the liquidation route.
Practical Tip:
Tax considerations should not be the only reason for disincorporation, and as such the owner may decide to take the ‘hit’ of extra tax that may be due on dividends from 6 April 2016.
