Incorporating a business

Introduction

The process of incorporation remains a necessity for any business that, despite recent tax rate changes, wants to trade as a limited company.

Incorporation is the transfer of an established business to a limited company.

This is a brief guide to the mechanics of incorporation.

Professional advice should always be taken based on specific circumstances.

Key Points

1. Company Formation

To form a private company limited by shares, the following must be sent to the Registrar of Companies, at Companies House in Cardiff (for England and Wales), Edinburgh (for Scotland) or The Department of Enterprise, Trade and Investment Company Registry in Belfast (for Northern Ireland):

Memorandum and Articles of Association
Details of directors, company secretary, members and registered office
(Companies Act 2006, Part 2).

A fee is payable.

CA 2006 s 270 removes the obligation for a private company to have a secretary.

The company should inform HM Revenue & Customs, (HMRC), in writing, within three months of coming within the charge to Corporation Tax (FA 2004 s 55). In practice Companies House informs HMRC of new company formations, and HMRC sends the company form CT41G for completion. If this does not happen, it is the company's responsibility to supply HMRC with the start up information requested on form CT41G.

2. Cessation of trade

The trade ceases in the unincorporated business for Income Tax purposes. Closing year rules apply. Overlap profits created on commencement are deducted from the profits of the final trading period.

The sole trader or partners usually become company directors and shareholders. Shares issued to them are regarded as having been issued and received by reason of employment. They should be issued at market value to avoid any benefits charge.

3. Trading losses

Unused trading losses may not be carried forward to the company. Normal loss reliefs are available:

ITA 2007 s 64 to set losses against current or prior year income;
ITA 2007 s 89 to set losses of the last 12 months against the trading income of the previous three years.

Additionally ITA 2007 s 86 allows unused trading losses to be used against income that the trader or partner derives from a company to which the trade has been transferred, and in which the trader or partner has been allotted shares.

4. Capital allowances

Cessation normally causes a deemed disposal of plant and machinery. For transfers to a connected person, (such as to the new company), market value is used to calculate the balancing adjustment. The transferor and company may jointly elect, within two years after the transfer date, for assets to be treated as transferred at Tax Written Down Value. (TWDV) (CAA 2001 ss 265-268). Industrial buildings are also deemed to be transferred at market value unless the parties elect to transfer at TWDV.

5. Trading stock

Transfers are at market value (ITOIA 2005 s 177), resulting in a trading profit for the transferor. The transferor and company may jointly elect, within two years after the transfer date, to substitute the higher of cost or price paid by the company if that would give a lower figure (ITTOIA 2005 s 178).

6. Capital Gains Tax (CGT)

Chargeable assets transferred are treated as disposals at market value (TCGA 1992 ss 17-18), resulting in a CGT liability for the transferor. Current assets, i.e., stock and debtors, are not chargeable assets. Plant and equipment is chargeable even where an election is made to transfer at TWDV for capital allowance purposes, as above. However, moveable plant and equipment may be covered by CGT exemptions. Therefore CGT is most likely to arise on freehold or leasehold premises, fixed plant and machinery, and goodwill acquired from the related party.

CGT (and SDLT - see below) on premises can be avoided by retaining outside the company. The owner may allow the company to use the property, and may charge rent.

7. Capital Gains Tax Reliefs

TCGA 1992 s 162 'incorporation relief' applies automatically on the transfer of a business to a company. Gains are deferred to the extent that consideration is received in the form of shares from the company. The deferred gain on the disposal of the business is deducted from the base cost of the shares acquired. The gain becomes chargeable when the shares are disposed of. It is possible to calculate non-share consideration, or simply to elect not to apply the relief, to make use of capital losses brought forwards, Entrepreneurs' Relief, Annual Exemption, etc. s162 requires all assets (except cash) to be transferred to the company. This can lead to a double CGT charge on an appreciating asset; CGT on the company's disposal of the asset, followed by CGT on the individual shareholder's disposal of the shares.

TCGA 1992 s 165 relieves gifts of business assets to the company. The gain arising on each asset is deducted from the base cost of that asset in the company, and deferred until the company sells the asset. Consideration for the assets may be cash or credit to the director's loan account. s165 allows retention of assets outside the company. This avoids SDLT on premises, and double-CGT-charges on appreciating assets. The transferor and company must jointly claim s 165 relief within five years from 31 January following the tax year of transfer to the company.

Enterprise Investment Scheme 'deferral relief' may be available if the company is a qualifying unquoted trading company. This alleviates the restrictions of ss 162 & 165 as it allows selective transfer of assets and transfers at market value. However the rules are complex.

8. Stamp Duty and Stamp Duty Land Tax (SDLT)

Stamp duty applies only to instruments relating to stocks and shares and marketable securities. It arises if these assets are included in the transfer agreement.

SDLT applies to land transactions. It arises if the premises are transferred. The transferor is connected with the company therefore SDLT is charged on the open market value, including any VAT on the transaction. (But see 9 below).

9. VAT

The transfer of a business to a company is a transfer of a going concern, outside the scope of VAT (subject to conditions). The company usually takes over transferor's VAT position. The sole trader or partnership must deregister. They and the company may claim for the existing VAT registration number to be transferred to the company.

10. Inheritance Tax

A transfer of business assets to a company with the same ownership is not a transfer of value. Therefore no IHT liability usually results.

Before incorporating your business, have a word with me to discuss the best strategy in your circumstances.