Capital Gains Tax on Incorporating a Property Business & Incorporation Relief

With the full deduction of mortgage interest no longer available for landlords owning property personally, running a property rental business through a limited company is an attractive prospect for many. However, whilst mortgage interest can be deducted in full when calculating the taxable profits of the company, it’s important that individuals are aware of the potential capital gains tax (CGT) liability that can arise on the transfer of properties to a limited company.

The Normal Capital Gains Tax Treatment on the Transfer of Properties to a Limited Company

The transfer of properties to a limited company would be a deemed disposal at market value for CGT purposes. This is on the basis that the transferor will be a shareholder in the company and will therefore be considered connected for the purposes of the tax legislation.

The net chargeable gain arising would therefore be the difference between the purchase price of the properties and the market value of the properties at the date of the transfer to the company (minus any available annual exempt amount and allowable enhancement expenditure).

The Effect of Incorporation Relief

Incorporation relief has the effect of reducing the net gain arising as a result of the transfer of any chargeable assets to the company (TCGA 1992, s.162 (2)).

The amount of relief depends upon the extent to which the consideration is represented by the issue of shares in the new company. Where other consideration is also received (such as cash or loan notes), the chargeable gains are apportioned between the shares and other consideration in accordance with their respective market value.

Where all of the consideration for the transfer is in shares in the limited company, and the other conditions for relief are satisfied, the net chargeable gain is reduced to nil and CGT is not payable on the transfer to the Company.

The deferred capital gain from the transfer to the Company reduces the base cost of the shares in the limited company and will become chargeable on a future sale/gift of the shares.

Conditions for Incorporation Relief to Apply

Broadly speaking, to qualify for incorporation relief, you must:

• Be a sole trader or in a business partnership; and
• Transfer the business and all its assets (except cash) in return for shares in the company.

The following conditions must also be satisfied:

1. A person who is not a company transfers a business to a company.

The first condition for relief requires that the transferor is not a company. The transferor can therefore be a sole trader or a partnership.

2. The business must be transferred as a going concern.

In order for incorporation relief to be available the business must be transferred as a going concern. In essence, this means that the business transferred is fully operational, so that it could be continued by the transferee without further input and without interruption (IR Commrs-v-Gordon, 1991).

It is therefore necessary to distinguish between the act of investing in property to hold as long-term investments and owning property for use within a business in order to determine whether a business is being operated and therefore whether incorporation relief is available.

3. The whole of the assets of that business (other than cash, if desired) are transferred to the company.

Incorporation relief requires that all the assets of the business be transferred, with the possible exception of cash (TCGA 1992, s.162(1)). This would include assets that are not shown on the balance sheet, for example goodwill. Therefore, the retention of any of the business assets (e.g., one property) other than cash would result in incorporation relief not being available.

4. The consideration given by the company for the transfer is wholly or partly in the form of its own shares issue to the transferor.

Full relief is given where the whole of the consideration for the transfer is in the form of shares in the company. Where the shares only form part of the consideration, only partial relief is given (TCGA 1992, s.162(4)).

Summary

Ultimately, incorporation relief is very useful when individuals wish to transfer their property business to a limited company for no consideration and do not wish to pay the upfront CGT liability that would otherwise occur as a result of the deemed disposal to the company.

However, if the conditions for relief are not met, or the individual can afford to pay the upfront CGT liability, selling the properties to the company for their market value in return for loan notes can also be a tax-efficient way of extracting future profits from the company, allowing the individual to withdraw profits from the Company up to the value of the loan notes without incurring an income tax liability.

It is always important to consider all of the options available when incorporating a property business as well as the conditions for relief. The conditions listed in this article provide a brief overview however it is important that a full analysis is completed prior to incorporation to determine whether every condition has been met whilst also considering recent HMRC guidance and case law. If you would like any further information regarding incorporating your property portfolio, contact the team for an initial discussion.

Disclaimer: This article is for general information only and is not intended to constitute individual advice. It is recommended that you seek independent tax advice.