You might be eligible to delay payment of Capital Gains Tax if you transfer your business to a limited company by using incporation relief. In return, you gain shares.
Incorporation Relief allows you to not pay any tax until you have sold or disposed of the shares that you have gained from becoming a limited company.
Capital Gains Tax is the tax that is added to the profit you make when you sell an asset that has increased in value. E.g. if you previously bought a machine for $500 and at a later date sold it for £2500. The gains is £2000 (£2500 – £500) and that value will be what Capital Gains Tax is applied to.
To learn more about Capital Gains Tax click this link.
Eligibility of Incorporation Relief
To be eligible for Incorporation Relief:
- You must be a sole trader or be in a business partnership
- You must transfer your business and all its assets to a limited company for shares in the company.
How do you claim Incorporation Relief?
If you are eligible for incorporation relief then you will automatically receive it. You are not required to take any action to receive incorporation relief.
How to calculate incorporation relief – shares.
In order to calculate the value you need to pay Capital Gains Tax on, you must deduct the gain you received when selling your business from value of the shares that you received.
A business transfers to a company, in return they gain £200,000 worth of shares. The company gains a profit of £120,000. The company then sells the shares at a later date. The cost for their Capital Gains Tax calculations is £80,000 as it is the (the market value of the shares – gain)/ (£200,000 – £120,000).
How to calculate incorporation relief – shares and cash.
You may also be given cash as well as shares when you transfer your business to a company. You will only be eligible for Incorporation Relief on the percentage you exchanged for shares.
A business transfers to a company, which is valued at £200,000. You receive 80% in shares and 20% in cash, this is valued at £160,000 in shares and £40,000 in cash. The company gains a profit of £100,000. The company is able to postpone paying Capital Gains tax on the 80% until the shares are sold. However, the company still needs to pay Capital Gains Tax on the 20% cash in the upcoming tax return.
INcorporating a property rental business
If you own a property rental business and want to incorporate that business you will face some up-front costs.
One cost is that you have to pay SDLT (Stamp duty land tax) again. The SDLT is based on the current market value of the property when it is transferred. If you would like to learn more about SDLT please click this link.
If you do not currently have a limited company and you wish to start a property rental business, you will need to set up a limited company first. After setting up the company, the company will purchase the rental properties. Once the properties are purchased, then the SDLT are required to be paid.
Companies do not have a personal allowance unlike individuals do which is currently £12,570. The amount that falls within personal allowance is taxable at a 0% rate. Therefore, corporation tax is taxable at the first £1 profit that is made.
On the 1st of April 2023, companies that make more than a £50,000 profit will be subject to increased corporation tax rates. However, these rates will remain lower than income tax rates so it may still be more beneficial to incorporate your business.
When having property within a corporate business you can be entitled to lower corporation tax rates and be able to repay debt more quickly. The income that is made can be accumulated within the company and can be distributed after retirement to avoid the higher tax rates.
Currently the Corporation Tax main rate is 19% as of 2021, while income tax rates are at 20%, 40% or 45%. Out of all of the income that is generated, if the shareholders do not require all of it then it can be used to pay off debts faster and be used for future investments. This can help the business to grow and flourish faster than it usually would.
In addition, the first £2,000 of dividends that are to be distributed to each individual will be taxable at 0%. This means that the more individuals that are entitled to dividends, the more tax you will be saving on.
When figuring out your taxable profits, you can take into consideration expenses that have been incurred for the sole purpose of your property business.
Costs of being unincorporated
Landlords that are running an unincorporated property business have been subject to reduced tax reliefs over the past few years. When working out their taxable profits, they are no longer able to take into consideration finance costs such as mortgage interest. In return, they are able to receive tax relief at a 20% reduction of the finance costs. This is regardless of the rate at which you pay taxes.
In contrary to landlords that are running an unincorporated property business. When working out taxable rental profits, an incorporated property company is able to deduct allowable financial costs in full.
Disposal of property
If and when a limited company decides to dispose of their property, the company will pay corporation tax on the chargeable gains. However, if you dispose of a property personally and the income gains are above the basic rate limit of £37,700 (as of 2021/22) then you will need to pay capital gains tax.
You will pay capital gains tax at 28% for the disposal of residential property and 20% for the disposal of commercial property. In spite of that, if your income gains are below the basic rate limit then you will only have to pay 18% for residential property and 10% for commercial property.
If you would like to know more, feel free to get in touch.