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Looking at doing my 1st incorporation. Sense check needed.

FireraiserFireraiser Feels At HomeRegistered Posts: 91
I have a client who is thinking of incorporating. The annual tax / NIC saving will only be about a grand, so obviously I want to keep CGT liability below this.

It's primarily a cash business so there are no debtors and, apart from a bank loan which probably won't be transferred to the company, no creditors. All fixed assets have been fully depreciated, so will be transferred at nil value. Goodwill will be about £50k and this comprises the full value of the business.

Let's assume the new company has 1000 shares with a face value of £1

If the client sells the business to the company for all those shares and no cash, then the client will automatically receive incorporation relief on £50k worth of shares. The share capital account will be £1000 and the share premium account will be £49000. There will be no director's loan account. There would be no CGT payable on incorporation. In this scenario, I don't know how my client could get their money out of the company other than by a reduction in capital.

Going to the other extreme; if the client sells the business to the company for 1000 shares plus £49k cash, there will be a DLA of £49k, share capital account of £1k and no share premium account. However there will be a CGT bill of £3840. Assuming this is paid for out of the DLA, there will be a balance of £45 160 which the client can draw on with no further tax implications.

I'm tempted to suggest something in between, say, 1000 shares plus £10 600, thus avoiding CGT. However that leaves share capital £1k, DLA £10 600 and share premium £38 400. Is there any reason why the company could not, in each of the following tax years, do a reduction in capital of £10600 (or whatever the CGT allowance is in that year) and then declare a dividend to allocate it to the share holder. In less than 4 years all the share premium would have been reallocated to the DLA with no CGT implications. This seems too good to be true, so I'm sure it is.

All comments and suggestions gratefully received.

Comments

  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »
    I have a client who is thinking of incorporating. The annual tax / NIC saving will only be about a grand, so obviously I want to keep CGT liability below this.

    It's primarily a cash business so there are no debtors and, apart from a bank loan which probably won't be transferred to the company, no creditors. All fixed assets have been fully depreciated, so will be transferred at nil value. Goodwill will be about £50k and this comprises the full value of the business.

    Let's assume the new company has 1000 shares with a face value of £1

    If the client sells the business to the company for all those shares and no cash, then the client will automatically receive incorporation relief on £50k worth of shares. The share capital account will be £1000 and the share premium account will be £49000. There will be no director's loan account. There would be no CGT payable on incorporation. In this scenario, I don't know how my client could get their money out of the company other than by a reduction in capital.

    Going to the other extreme; if the client sells the business to the company for 1000 shares plus £49k cash, there will be a DLA of £49k, share capital account of £1k and no share premium account. However there will be a CGT bill of £3840. Assuming this is paid for out of the DLA, there will be a balance of £45 160 which the client can draw on with no further tax implications.

    I'm tempted to suggest something in between, say, 1000 shares plus £10 600, thus avoiding CGT. However that leaves share capital £1k, DLA £10 600 and share premium £38 400. Is there any reason why the company could not, in each of the following tax years, do a reduction in capital of £10600 (or whatever the CGT allowance is in that year) and then declare a dividend to allocate it to the share holder. In less than 4 years all the share premium would have been reallocated to the DLA with no CGT implications. This seems to good to be true, so I'm sure it is.

    All comments and suggestions gratefully received.

    When did the sole trade business start trading?

    If it was after 06/04/2002 then the £50,000 of goodwill (as it is amortised and written off) will give rise to £10k of corporation tax relief (i.e. the £50k over lets say 10 years would be an allowable expense at £5k/year).

    Therefore the cgt cost maybe £3,840 but the ct saving would be £10k giving a net saving of £6,160 + the credit in the loan account.
  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »
    I have a client who is thinking of incorporating. The annual tax / NIC saving will only be about a grand, so obviously I want to keep CGT liability below this.

    It's primarily a cash business so there are no debtors and, apart from a bank loan which probably won't be transferred to the company, no creditors. All fixed assets have been fully depreciated, so will be transferred at nil value. Goodwill will be about £50k and this comprises the full value of the business.

    Let's assume the new company has 1000 shares with a face value of £1

    If the client sells the business to the company for all those shares and no cash, then the client will automatically receive incorporation relief on £50k worth of shares. The share capital account will be £1000 and the share premium account will be £49000. There will be no director's loan account. There would be no CGT payable on incorporation. In this scenario, I don't know how my client could get their money out of the company other than by a reduction in capital.

    Going to the other extreme; if the client sells the business to the company for 1000 shares plus £49k cash, there will be a DLA of £49k, share capital account of £1k and no share premium account. However there will be a CGT bill of £3840. Assuming this is paid for out of the DLA, there will be a balance of £45 160 which the client can draw on with no further tax implications.

    I'm tempted to suggest something in between, say, 1000 shares plus £10 600, thus avoiding CGT. However that leaves share capital £1k, DLA £10 600 and share premium £38 400. Is there any reason why the company could not, in each of the following tax years, do a reduction in capital of £10600 (or whatever the CGT allowance is in that year) and then declare a dividend to allocate it to the share holder. In less than 4 years all the share premium would have been reallocated to the DLA with no CGT implications. This seems to good to be true, so I'm sure it is.

    All comments and suggestions gratefully received.

    I don't think you can avoid the cgt bill to be honest as there is a business asset, in this case is goodwill, which is being disposed of by the sole trader (who is ceasing trade) to the limited company. CGT rules state that this disposal is going to have to occur at market value hence the gain and the cgt.
  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »
    I have a client who is thinking of incorporating. The annual tax / NIC saving will only be about a grand, so obviously I want to keep CGT liability below this.

    It's primarily a cash business so there are no debtors and, apart from a bank loan which probably won't be transferred to the company, no creditors. All fixed assets have been fully depreciated, so will be transferred at nil value. Goodwill will be about £50k and this comprises the full value of the business.

    Let's assume the new company has 1000 shares with a face value of £1

    If the client sells the business to the company for all those shares and no cash, then the client will automatically receive incorporation relief on £50k worth of shares. The share capital account will be £1000 and the share premium account will be £49000. There will be no director's loan account. There would be no CGT payable on incorporation. In this scenario, I don't know how my client could get their money out of the company other than by a reduction in capital.

    Going to the other extreme; if the client sells the business to the company for 1000 shares plus £49k cash, there will be a DLA of £49k, share capital account of £1k and no share premium account. However there will be a CGT bill of £3840. Assuming this is paid for out of the DLA, there will be a balance of £45 160 which the client can draw on with no further tax implications.

    I'm tempted to suggest something in between, say, 1000 shares plus £10 600, thus avoiding CGT. However that leaves share capital £1k, DLA £10 600 and share premium £38 400. Is there any reason why the company could not, in each of the following tax years, do a reduction in capital of £10600 (or whatever the CGT allowance is in that year) and then declare a dividend to allocate it to the share holder. In less than 4 years all the share premium would have been reallocated to the DLA with no CGT implications. This seems to good to be true, so I'm sure it is.

    All comments and suggestions gratefully received.

    And there's always incorporation relief:

    http://www.hmrc.gov.uk/helpsheets/hs276.pdf
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    I'm pretty sure that the business has been trading since before 2002. The current owner acquired it from a parent and I'm reasonably sure it's been going since at least the 80s.

    However, there is no goodwill currently in the accounts, so if it ever existed it has been fully amortised. I was under the impression that the goodwill would be created on the transfer to a new owner to reflect the difference in the value of the business and the value of the tangible assets. So I would have thought that amortisation couldn't start until after the transfer of the business ???
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    Incorporation relief is available only on that part of the consideration which is paid in shares?? That;s why I thought by using it, we'd have a large share premium account and a small DLA making it difficult for the director / owner to get their money out of the company.
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    reader wrote: »
    I don't think you can avoid the cgt bill to be honest as there is a business asset, in this case is goodwill, which is being disposed of by the sole trader (who is ceasing trade) to the limited company. CGT rules state that this disposal is going to have to occur at market value hence the gain and the cgt.

    I'd be really surprised if I could avoid the CGT bill, unless I use incorporation relief which gives the problem of getting money out of the company. However, I haven't yet seen anything which says that my last scenario isn't possible. As I said, it sounds too good to be true so probably is, but I'd really like to see something which shows it's not possible before I discount it completely.

    I found this on CH website which doesn't seem to give any restrictions on the number of times a company can reduce its capital by means of a solvency statement;

    Reduction supported by a solvency statement

    A private limited company can reduce its capital by special resolution supported by a solvency statement (so long as the reduction does not result in only redeemable shares being held). You must deliver to Companies House:

    a copy of a special resolution authorising the capital reduction;
    a copy of the solvency statement made in accordance with sections 642(1)(a) and 643 of the Companies Act 2006;
    a statement of capital;
    a statement of compliance by the directors.
    a fee of £10 for the standard service or £50 for the same day service.
    All the company directors must sign the solvency statement.

    A statement of compliance by the directors confirms that the company made a copy of the solvency statement available to each of the eligible members as required and that the directors did not make the solvency statement more than 15 days before the company’s members passed the resolution. All the directors must sign this statement of compliance.

    All of these documents must be delivered to Companies House within 15 days of the resolution being passed. Wherever possible, you should deliver all the forms together. The reduction of capital will not take effect until Companies House has registered a copy of the solvency statement, resolution and statement of capital.
  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »
    I'd be really surprised if I could avoid the CGT bill, unless I use incorporation relief which gives the problem of getting money out of the company. However, I haven't yet seen anything which says that my last scenario isn't possible. As I said, it sounds too good to be true so probably is, but I'd really like to see something which shows it's not possible before I discount it completely.

    I found this on CH website which doesn't seem to give any restrictions on the number of times a company can reduce its capital by means of a solvency statement;

    Reduction supported by a solvency statement

    A private limited company can reduce its capital by special resolution supported by a solvency statement (so long as the reduction does not result in only redeemable shares being held). You must deliver to Companies House:

    a copy of a special resolution authorising the capital reduction;
    a copy of the solvency statement made in accordance with sections 642(1)(a) and 643 of the Companies Act 2006;
    a statement of capital;
    a statement of compliance by the directors.
    a fee of £10 for the standard service or £50 for the same day service.
    All the company directors must sign the solvency statement.

    A statement of compliance by the directors confirms that the company made a copy of the solvency statement available to each of the eligible members as required and that the directors did not make the solvency statement more than 15 days before the company’s members passed the resolution. All the directors must sign this statement of compliance.

    All of these documents must be delivered to Companies House within 15 days of the resolution being passed. Wherever possible, you should deliver all the forms together. The reduction of capital will not take effect until Companies House has registered a copy of the solvency statement, resolution and statement of capital.

    There are a number of anti-avoidance provisions to prevent tax payers from evading tax by entering into a series of transactions, e.g S.286, TCGA 1992
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    reader wrote: »
    When did the sole trade business start trading?

    If it was after 06/04/2002 then the £50,000 of goodwill (as it is amortised and written off) will give rise to £10k of corporation tax relief (i.e. the £50k over lets say 10 years would be an allowable expense at £5k/year).

    Therefore the cgt cost maybe £3,840 but the ct saving would be £10k giving a net saving of £6,160 + the credit in the loan account.

    I am so glad of this forum, it's just saved me from a big mistake. I had totally misunderstood the rules round CT relief against intangible fixed asset amortisation and would have fallen foul of http://www.hmrc.gov.uk/avoidance/spotlights1.htm

    I'm now tending towards £10 600 cash and the balance in shares to take advantage of incorporation relief.
  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »

    I'm now tending towards £10 600 cash and the balance in shares to take advantage of incorporation relief.

    The only capital gains relief that I know of where you can specifically restrict the amount of relief that you want to claim in order to utilise the annual exemption is EIS reinvestment relief. All other capital gains reliefs that I know of, e.g. gift relief, are "all or nothing" reliefs, i.e. you can't elect to reduce the relief that you are claiming in order to utilise the annual exemption. I think this would be especially true of incorporation relief given that this is an automatic relief where no claim is even made.

    If you're going for incorporation relief I would just use £1 of share capital to be honest (or maybe £2: one for your client and one for your client's spouse). I don't see why you would need any more share capital or any share premium.

    Given that incorporation relief is automatic you don't have to worry about your client's cgt until your client sells up. When your client sells up he/she will have a larger cgt liability than if they had not used incorporation relief (as all incorporation relief is doing is just deferring/rolling over the capital gain until the business is sold).
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    reader wrote: »

    If you're going for incorporation relief I would just use £1 of share capital to be honest (or maybe £2: one for your client and one for your client's spouse). I don't see why you would need any more share capital or any share premium.

    That would value the business at £1 (no spouse involvement), surely HMRC wouldn't accept that as a true valuation of an ongoing profitable business?

    My understanding, and please correct me if I'm wrong, is that incorporation relief only applies to consideration in shares in the transferree company. If the business is valued at £50k, the net assets on transfer will be £50k. As there will be no liabilities, the equity must be £50k. If the share capital is £1 then share premium would have to be £49 999. I assume that the £49 999 can't be shown as retained earnings as it doesn't meet the definition.

    I'm missing something, aren't I?
  • readerreader Experienced Mentor MAAT, AAT Licensed Accountant Posts: 1,042
    Fireraiser wrote: »
    That would value the business at £1 (no spouse involvement), surely HMRC wouldn't accept that as a true valuation of an ongoing profitable business?

    My understanding, and please correct me if I'm wrong, is that incorporation relief only applies to consideration in shares in the transferree company. If the business is valued at £50k, the net assets on transfer will be £50k. As there will be no liabilities, the equity must be £50k. If the share capital is £1 then share premium would have to be £49 999. I assume that the £49 999 can't be shown as retained earnings as it doesn't meet the definition.

    I'm missing something, aren't I?

    Regarding shares, their nominal value and their market value:

    Shares have a nominal value and a market value. For example, a share with a nominal value of £1 can have a market value of £50,000.

    In HMRC's example 1, each share with nominal value of £1 has a market value of £100. HMRC understand (see example 2 as well) that the nominal value of a share (i.e. £1) will be completely different to its market value (i.e. £80).

    Can you give me that link that says HMRC wants nominal value and market value to be the same?

    Regarding share premium and incorporation relief:

    Again, study examples 1 and 2. In these examples the business is worth £100,000 but only £1,000 of share capital is issued.

    Can you give me the link that says incorporation relief only applies to the consideration of shares?

    You've mentioned that HMRC:
    1) want share nominal value = market value for "true valuation" purposes
    2) "incorporation relief only applies to consideration in shares"
    but I can't seem to find where exactly you're getting these ideas from. Help?
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    reader wrote: »

    Can you give me that link that says HMRC wants nominal value and market value to be the same?

    No, I didn't intend to give that impression.
    reader wrote: »

    Can you give me the link that says incorporation relief only applies to the consideration of shares?

    I get this from my reading from http://www.hmrc.gov.uk/helpsheets/hs276.pdf, in particular;

    If you, either as an individual or in partnership, incorporate a business by transferring the business, together with all the assets of the business, in exchange wholly or partly for shares, you can defer some or all of the gain arising from the disposal of the ‘old assets’ (the business and the assets of the business) until such time as you dispose of the ‘new assets’ (the shares).


    and

    Example 2
    Bill Brown incorporated his business in May 2011 and received 1,000 £1 ordinary shares in CDE Ltd and £20,000 in cash. The business was worth £100,000 on incorporation, so that the shares had a market value of £80 each, and the agreed chargeable gain on the
    assets transferred amounted to £50,000. Mr Brown does not pay all of the Capital Gains Tax immediately. The part of the gain attributable to the consideration in shares is
    £50,000 x £80,000/£100,000 = £40,000. This part of the gain is deferred. His cost of the shares for the purposes of any future disposal would normally be £80,000 but this is reduced by the amount of the deferred gain £40,000, leaving a base cost of £40,000. Mr Brown is liable to tax on the balance of the chargeable gain, £10,000, for the
    year 2011–12.


    If my client were to incorporate with a chargeable gain of £50k receiving consideration in the form of one £1 share with a market value of £50k how would that be shown in the accounts other than by £1 share capital and £49 999 share premium? If it were shown as £1 share capital and £49 999 DLA, wouldn't this incur a chargeable gain of £49 999 which could not be rolled over via incorporation relief?
  • stevo5678stevo5678 Well-Known Cheltenham Registered Posts: 325
    Other option is to not provide for goodwill. Who's going to bat an eye lid?

    Seen this done a million times...
  • FireraiserFireraiser Feels At Home Registered Posts: 91
    stevo5678 wrote: »
    Other option is to not provide for goodwill. Who's going to bat an eye lid?

    Seen this done a million times...

    So this would value the business at £1 (assuming 1 x £1 share)? Is that acceptable as it doesn't reflect the market value of the business.
  • stevo5678stevo5678 Well-Known Cheltenham Registered Posts: 325
    Sorry to bring up and old thread Reader but I am pretty sure that Fireraiser is correct here as I am currently on the same subject and have had to investigate.

    Look at page 78 of this incorporation book.

    http://books.google.co.uk/books?id=frYqQU5jSxsC&pg=PA80&lpg=PA80&dq=incorporation+relief+sale+at+undervalue&source=bl&ots=ai1NFJSFEE&sig=NR4AXPzhXVDPnjzn0pyo0PfTw84&hl=en&sa=X&ei=qEQqUdWAIsrU0QWjj4oGYCw&ved=0CFwQ6AEwBw#v=onepage&q=incorporation%20relief%20sale%20at%20undervalue&f=false

    You can take advantage of the AA for CGT by manipulating the consideration in shares and in cash as cash is not part of the formula for relief. DLA credits is deemed as cash. Anything you bank in the DLA via a CR is not allowable for S162 as it is cash hence why Fireraiser was constantly referring to share premium which is a form of share capital created as to not take the cash out upon transfer.

    However if your taking the hit on ER tax at 10% in full then there is no issue but this is also not then a s162 case.

    My issue is if I've created goodwill and a share premium account and lets say the Director takes out all his profits each year the B/S will end up with virtually nothing in assets once GW has been w/o. Say all we've got is GW in assets and a share prem. a/c. GW will amortize each year so say in year 10 it'snil. If nothing else has happened (just to explain) the I've got nil assets at the top of the BS equation a huge share capital balance at the bottom less the P & L losses b/f for GW amortization.

    EG

    ASSETS

    Goodwill - Nil (was £50k 10 years ago)

    FINANCED BY

    Share capital £1
    Share premium £49,999
    P & L a/c (£50,000) (w/o of goodwill)

    Is this an allowable balance sheet???

    Thanks in advance
  • stevo5678stevo5678 Well-Known Cheltenham Registered Posts: 325
    You can also manipulate the CGT AA via s165 using a sale of goodwill at undervalue - see page 86 of the link.
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