Incorporation Relief — Transferring property into a Limited Company
Capital Gains Tax (“CGT”) Issues
Transferring a business into a limited company is considered a disposal by the individual, with the disposal taking place at market value (MV) on the transfer date, thus triggering a capital event and therefore very likely a CGT liability. Incorporation relief is available when a sole trader or partnership incorporates their business into a company in exchange for shares. Incorporation relief defers any CGT liability and reduces the base cost of the shares in the new company. To qualify for incorporation relief, the transfer must be from a sole trader or a business partnership, and you the entire business and all its assets (except cash) must be transferred in return for shares in the company.
Incorporation relief is automatic, and no separate election is required. However, if the consideration received from the company includes cash in addition to shares, the portion of CGT related to the cash becomes immediately chargeable.
Stamp Duty Land tax (“SDLT”) Issues
When a property business is transferred to a company, SDLT is normally payable on the MV of the property, even if no chargeable consideration is given. SDLT applies under the following conditions:
The person transferring the property is connected to the company. This includes relatives or individuals involved with the company.
The company pays for the property using shares (partly or wholly) issued to a person connected to the company.
As a result, even with incorporation relief for CGT, SDLT will normally still be charged on the company as a result of the transfer process.
In certain circumstances, if the property business is a partnership (a partnership business that holds UK property) and is transferred to a company SDLT relief may be available.
Circumstances for SDLT Relief via Partnership Incorporation:
Genuine Partnership: The property must be owned by the partnership and not by just two individuals. The partnership must be a genuine business with active involvement by the partners, such as renting out properties.
Partnership Registration: The partnership should be registered with HMRC, have a separate bank account, and ideally, a partnership agreement in place.
Active Involvement: The active involvement requirement applies only to ordinary partnerships, not to limited partnerships or limited liability partnerships (LLPs). However, the active involvement test must still be satisfied to qualify for incorporation relief for CGT purposes.
Control Over the Company: To benefit from SDLT relief, the partners must be connected to the newly formed company and have control over it.
Previous SDLT Payment: SDLT relief generally applies only if SDLT was correctly paid when the partnership purchased the property. Relief extends only to the extent that proper SDLT was paid on any increase in a partner’s share since the property’s purchase.
No Chargeable Consideration: The incorporation must not involve chargeable consideration. Issuing new shares in exchange for partnership property can be considered chargeable. Instead, the company should be incorporated with shares distributed in proportion to the existing partnership interests from the outset. The shareholding percentage in the company must match the ownership percentage in the partnership. Any discrepancy could be seen as a transfer of value between partners and may lead to a chargeable consideration.
No Cash Involvement: Cash must not be part of the transaction at the time of the transfer, as it would be treated as chargeable consideration.
Example of SDLT on Partnership Incorporation:
Scenario 1:
A partnership consists of three partners: Mr Smith, Mrs Smith, and Mr Jones. The partnership owns a freehold property with a market value (MV) of £250,000. Mr and Mrs Smith, who are married, each hold a 20% interest in the partnership, giving them a combined 40% interest. The remaining 60% is owned by Mr Jones.
Mr Smith controls a company called SS Ltd. The partnership decides to transfer the property to SS Ltd, which pays £200,000 for the property. Since Mr and Mrs Smith are connected to the company (due to Mr Smith's control), SDLT will be based on the MV of the property. Mr and Mrs Smith are transferring their 40% interest, so SDLT will be charged on the remaining 60% of the property, which they do not own. Therefore, SDLT will be calculated on 60% of £250,000, i.e., £150,000.
Scenario 2:
In a similar situation, the partnership again consists of Mr Smith, Mrs Smith, and Mr Jones, with the same property valued at £250,000. However, this time, SS Ltd is owned by the partners in the same proportions as the partnership (Mr Smith 20%, Mrs Smith 20%, Mr Jones 60%). In this case, SDLT relief applies under the partnership relief provisions, and the SDLT charge will be fully exempt, meaning no SDLT is payable.
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Authored by: London Team