‘Disincorporation Relief’
12th March 2021
Posted in Articles, Corporation Tax by Andrew Marr
The issue
Last week I discussed how from 1 April 2023 there will be a top effective rate of tax of 54.5% for shareholders who extract profits from their companies. This is based on the interaction between the marginal rate of corporation tax of 26.5% (between £50,000 and £250,000 of profits) and the top dividend tax rate of 38.1%. In contrast, sole traders and partnerships continue to face a top marginal tax rate of 47% (45% income tax and 2% NIC) . The question on the lips of many shareholders will therefore be ‘How do I disincorporate?’ or ‘I’m a shareholder. Get me out of here!’.
I must now confess that I may have misled you somewhat with the title of this Tax Bite. Although there is the widely-known, section 162 incorporation relief (allowing a business to be transferred to a company in exchange for shares, without triggering a gain) there is no equal and opposite relief for ‘disincorporations’. Although there was previously a very limited relief which applied from 1 April 2013, this ended on 31 March 2018.
‘Just stop using the company’
I have heard many shareholders explain that they may just stop using their company from 1 April 2023. By this they mean that from that date they will start invoicing their customers either individually, or through a partnership (and presumably extract remaining reserves from the company over time).
Prima facie this seems viable, but there are significant traps to be aware of.
Firstly, HMRC may argue that the company has disposed of goodwill to its shareholder and therefore seek to assess the company to a chargeable gain. Secondly (and on a similar theme) they could argue that the shareholder has received a distribution of the goodwill which would be taxable at dividend rates. These points show precisely why we need a disincorporation relief. Any such relief would presumably work by the shareholder taking on the base cost of any goodwill from the company and not being taxed on a distribution.
There will, however, be cases where this approach works.
For example, in many companies any goodwill will be so inextricably linked to the shareholder, that it has a negligible market value. A third party would be unlikely to pay for goodwill if it was inextricably linked to the shareholder and if that shareholder were to continue to charge significant fees for his services. It may, however, be difficult to get advance clearance from HMRC on this point using the non-statutory clearance procedure. Hence, it would take a brave shareholder to rely on this analysis.
Forbes Dawson view
Although I would expect to see a rise in the use of LLPs for new business structures and new ventures, it will not always be easy, or viable, from a tax perspective for existing companies to ‘disincorporate’. For many there may need to be a ‘halfway house’ whereby the shareholder charges his company for certain services, either individually, or via an LLP. It also strikes me that there may be scope to use some of the mixed partnership rules as a means of getting profits taxed at the individual level. I need to look at this point in more detail but it is clear that great care would be needed.
