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Do you qualify for disincorporation relief?

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The issue of whether or not to incorporate your business into a limited company is an important early decision to make. There can be tax planning advantages to incorporation as it creates flexibility over levels of income chargeable to personal tax, and prevents profits from immediately becoming chargeable to tax at the highest personal tax rates. There are also other commercial benefits.

For some businesses, however, incorporation does not work out to be a beneficial option. For instance, following the introduction of the zero per cent rate of corporation tax in 2002-03, many small businesses incorporated to save tax. The zero rate was then abolished because, according to the government, companies were taking advantage of the tax saving opportunities. Those company owners may subsequently have wished to disincorporate their business, only to find it was a difficult procedure, fraught with tax charges. As a result, they may find their business “trapped” within a corporate structure.

Another reason for wanting to disincorporate may be to avoid the additional administrative and regulatory requirements of being a limited company, especially if profits are decreasing and the tax benefits offered by sheltering profits within a company are no longer beneficial. In addition, for business owners who are not used to maintaining a clear distinction between their business finances and personal cash, financial administration can be simpler outside a company. For this reason, they may find it easier to operate outside the legal structure of a company entity.

Historically, disincorporating a company has attracted tax charges because the valuable reliefs, which are available when you incorporate a business, are not available when you disincorporate it. Therefore, it could be a costly exercise for a limited company to reverse its decision to incorporate. Since 1 April – following a detailed consultation process – a new “disincorporation relief” has been introduced by the government for a period of five years.

This new tax relief was designed to help avoid the tax charges incurred by companies who want to change their status into a non-corporate structure; for example, sole trader or partnership. The relief applies only to companies which have assets with a value of less than £100,000 – estimates from the Treasury suggest this is approximately 40 per cent of all companies registered in the UK.

Criteria to qualify for disincorporation relief

Below is a simplified summary of the main eligibility criteria:

  • The company must have been operational for 12 months;

  • An incorporated business must transfer some/all of the trading business to the existing company shareholders as a going concern;

  • The transfer must become effective within five years of March 31st 2013;

  • All assets, including goodwill, capital assets, trading stock and cash, must be included in the transfer. The value of those assets must be no greater than £100,000;

  • Recipients of the new “disincorporated” entity must either be individuals or partnership members; they cannot be members of an LLP; and

  • All shareholders must have owned their shares for at least 12 months before the transfer is made. So, an incorporated business cannot be less than 12 months old before being eligible for disincorporation relief.

Lesley Stalker is head of tax at Surrey accountants RJP.

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