How Incorporation Relief can mess up Business Asset Disposal Relief (BADR)

Section 162 TCGA 1992 is a handy piece of legislation which allows business owners to incorporate without triggering an immediate capital gain. This works if the following conditions are satisfied:

  1. All business assets apart from cash are transferred.
  2. Shares are given as consideration.

It works by deferring any gain which would otherwise have been made into the base cost of the shares.


Alexander incorporates his tax consultancy business (which was set up in 2010) by transferring various assets and liabilities of the business worth £300,000 and goodwill worth £2m in exchange for shares in the recipient company which is a large accountancy practice (Large Accountancy Co). Although Alexander is prima facie disposing of £2m of goodwill which would trigger a £300,000 capital gains tax bill (£1m at 10% and £1m at 20%) section 162 relief should be applicable for this gain. Therefore, although the value of the share consideration here is £2.3m, for tax purposes the shares would have a base cost of £300,000.

Suppose that Large Accountancy Co is then sold 18 months after incorporation (with Alexander’s proceeds being £2.3m) and Alexander wants to know what his tax liability would be. The tax liability would now be £400,000 which is £100,000 higher than the liability which would have been triggered on the incorporation of the business had section 162 not applied. This is because (perhaps surprisingly) there is nothing that gives Alexander Co automatic BADR status in these circumstances. As the shares have not been held by Alexander as a trading company for two years then they would not qualify.

What can be done here?

In these circumstances it may be appropriate for Alexander to make an election for section 162 not to apply. If the share disposal takes place by the end of the tax year after the incorporation took place, then such an election can be made by 31 January following that subsequent tax year. Otherwise, the deadline is two years from 31 January following the tax year of incorporation. This means that there should generally be time to make an election in circumstances where BADR has been denied. In such circumstances there would be a tax charge on the incorporation, but the base cost of the shares would be restored to £2.3m and so the share sale would only give rise to a gain to the extent that proceeds are above this value.

Alternatively, if the business had first been incorporated into an existing trading company which qualifies for BADR (5% shares and voting rights etc) then BADR should be available on that immediately. This is because the two-year period does not apply to the shares per se (the ones issued on incorporation) but just the period for which the qualifying conditions have been met in relation to the company. Large Accountancy Co could then have acquired those shares as part of a share for share exchange and the BADR status would continue. Admittedly, this form of planning would only be available in limited scenarios because it involves a significant change to the commercial structure of the deal.

Forbes Dawson view

The main take home point here is that the BADR holding period is not ‘inherited’ in relation to the company that receives a business on incorporation. This is somewhat at odds with the accepted position where a company takes over another company by way of a share for share exchange. In that case (as mentioned above) the new company will effectively take on the history of the old company for the purposes of BADR. Usually, this point will not bite because the shares in the trading company will be held for two years before sale (although two years is double the previously required holding period of one year). For incorporations to connected companies BADR would not be available for goodwill in any event and so in these cases the rule must simply be to try to incorporate at least two years before any sale.




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