Some people have mentioned that time is running out for applying disincorporation relief, and they are right. However, if truth be told, with all the recent changes to dividend taxation the whole thing has been a bit of a damp squib. This explains the basis of the relief and some, perhaps, little-known consequences.
A new relief was introduced in Finance Act 2013 enabling small companies to disincorporate and transfer their trade and assets to their shareholders. The relief was brought in to make it easier for the owners of small businesses, many of whom incorporated in the early 2000’s, to go back to be being unincorporated without suffering a tax penalty.
Relief is available for disincorporation’s taking place between 1 April 2013 and 31 March 2018 and so we are now into the last 12 months of availability.
The relief can be claimed where a company transfers its business and assets to some, or all of its shareholders and all of the following conditions are met:
Unlike incorporation relief, disincorporation relief does not apply automatically. A claim for this relief must be made jointly by the company and all of the shareholders to whom the business is being transferred. A claim must be made within two years of the date of the business transfer and is irrevocable.
Without a claim; a transfer of the trade and assets of the company to a shareholder are, for capital gains tax purposes, deemed to take place at their market value, in view of the fact that the company and the shareholder are connected.
When a claim for disincorporation is made, the qualifying assets are transferred at the lower of cost and market value. The effect is that no chargeable gain (or taxable profits) will crystallise on the transfer of the qualifying assets.
Unfortunately, although disincorporation relief is helpful from a capital gains tax angle, the relief does not apply to income tax. An income tax charge may arise on the transfer if it takes place at below market value. This will be treated as a dividend in specie for the shareholder and will subject to tax at the dividend rates.
As the transfer is between connected parties the transfer of stock will be deemed to have taken place at a full market value. However, the stock can be transferred at the higher of acquisition cost, or actual consideration paid, if a joint election is entered into, meaning there will be no profit in the company and therefore no corporation tax payable. The flip side is that the acquisition cost of the stock for the shareholder will be lower, leading to a higher profit when the stock is eventually sold.
The danger here as I have discussed above, is that where a transfer below market value has occurred there will be a dividend in specie for the shareholder.
Don’t forget that corporation tax rates have reduced since the relief was first introduced in FA2013 and are currently at 19%, whereas dividend rates have increased with additional rate tax payers now suffering a 38.1% dividend tax rate.
In practice, the take-up has been very small. With the added burden of an income tax charge without receiving any cash, it isn’t difficult to see why.
The relief was originally aimed at very small businesses; in other words basic rate taxpayers. As a result, a transfer occurring at less than market value (as long as it was within the basic rate tax band) previously would not have given rise to an income tax liability, due to the historical 0% dividend tax rates.
The relief is not to suitable to everyone, but it does offer the chance for very small companies that do not really need to be trading through a corporate entity to revert to being a sole-trader.
As mentioned in the opening lines, time is running out but in reality, what is the rush? There are alternatives for closing a company that in fact give a better tax result than disincorporation.
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