At the Autumn Statement 2014 it was announced that entrepreneurs’ relief (ER) will no longer be available to reduce capital gains tax (CGT) on the incorporation of a business.
HM Revenue & Customs (HMRC) states that if a company acquires a business from a sole trader or partner and pays them for the goodwill created in the old business the payment is liable to CGT. However, if the business qualified for ER, the tax rate chargeable was just 10%. Since 4 December 2014, ER no longer applies where goodwill is sold to a company that the original business owner is connected to. Instead, CGT at up to 28% is payable.
This measure was introduced in an attempt to remove the unfair advantage available to business owners and partners who sell their business to a close company to which they are already related in order to extract funds from the business via a low rate of CGT. Those affected by this new measure are predominantly sole traders and partners. However, despite scrapping ER, it can still be beneficial for businesses to incorporate and sell goodwill. This is due to the fact that CGT at 28% is a cheaper way to extract money from a company, rather than through salary.
The only problem you need to be aware of is that when a business is incorporated the company that has been created frequently has little or no cash to pay for the goodwill. Therefore, the payment is usually left as a debt and the sole trader or partner cannot access the money until later on. However, the CGT is required to be paid immediately.
Top Tip. If you incorporate your business shortly after 5 April you may have up to 22 months before the CGT needs to be paid. This is because the CGT is required by 31 January following the end of the tax year in which the goodwill was sold.
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