Your accountants have suggested transferring your business to a limited company to save tax and NI. While you’re leaving the red tape up to them are there any steps you can take to make the transfer even more tax efficient?
Incorporating your business
Despite anti-avoidance measures sole traders and partnerships can save tax and NI by transferring their businesses to a company. An unincorporated business that’s transferred to a company ( incorporating the business ) is treated as if it permanently ceased. This means that special tax rules for calculating taxable profits apply. One of these says that the equipment owned by the business is treated as if it were sold at market value and acquired by the company at the same price. This usually results in adjustments to the tax deductions, i.e. capital allowances (CAs) previously claimed by the old business. Tip. The hassle of valuing equipment and making adjustments to CAs can be avoided if the sole trader/partnership and the company jointly elect to treat the equipment as sold and acquired at the tax value instead of the market value.
Example. Josh and Ali are the partners of a delivery business. It prepares its annual accounts to 30 April. In February 2021 the partnership bought three new vans costing £90,000 in total. On 1 May 2021 they transferred the business to Acom Ltd, wholly owned by Josh and Ali. Usually, it could claim CAs for the whole £90,000 (using its annual investment allowance), but the rules don’t allow businesses to use the AIA in their final accounting period. The CAs are limited to the difference between £90,000 and the market value of the vans on the date the business is transferred, zero if the election mentioned earlier is made.
Trap. Another special rule applies when a business is incorporated. It says that a business is not entitled to the AIA on assets transferred to it. This means Acom can’t claim CAs for the whole £90,000 expenditure on the vans all at once. Instead, it gets a CAs “writing down allowance”. This spreads the tax deduction over many years.
Spreading capital allowances
In our example Acom is only entitled to CAs at the rate of 18% pa of the reducing balance of the cost/value transferred from the partnership. In summary, because the purchase of the vans occurred in the final trading period of the unincorporated business, Josh and Ali miss out on CAs of up to £90,000 which instead is received by Acom but spread over more than 20 years.
Tip. Josh and Ali can prevent the loss/delay of CAs by changing their accounting period so that the end date falls between when they bought the vans (February 2021) and the date they transferred the business (1 May 2021).
Example. The partnership changes its accounting period so that its penultimate accounts run from 1 May 2020 to 31 March 2021. The final accounts cover 1 April to 30 April 2021. The purchase of the vans therefore falls in the partnership’s penultimate accounting period meaning that it gets CAs on the full £90,000. Josh, Ali and Acom also elect to use the tax value which is zero (£90,000 expenditure less £90,000 CAs received by the unincorporated business), for the transfer of the vans to Acom. For relatively little effort the CAs trap, which substantially delays tax relief for the vans, has been avoided.
As far as possible avoid buying equipment in the final accounting period before the business is incorporated. If that’s not possible change the accounting date so that the expenditure falls into the penultimate accounting period rather than the final one.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.