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Conditions for incorporation relief

There still seems a lot of confusion over what constitutes a business for tax purposes and will qualify for Incorporation relief.  Many qualified accountants are still giving wrong tax advice!

(1) A person who is not a company transfers a business to a company

A ‘company’ includes any body corporate, unincorporated association or unit trust scheme but does not include a partnership (TCGA 1992, s. 288(1)) or a limited
liability partnership (TCGA 1992, s. 59A(1)). The definition in s. 288(1) also extends to unit trust schemes. This is essentially the same definition of ‘company ’ as
applies in relation to the Taxes Acts generally (see ¶700-550). It therefore follows that relief is available to sole traders, partners and trustees or personal 
representatives. See also comments at ¶574-100 for further comment on partnership incorporations, in particular where there are corporate partners.

There is no requirement that the recipient company must be UK resident nor that it should be within the charge to UK tax in respect of that business following the transfer. As the gain is rolled-over onto the shares held by the UK resident former proprietor, which are still within the scope of UK capital gains tax, the tax status of the company is irrelevant.

It is noteworthy that the statute refers to the transfer of a ‘business ’ and not a ‘trade’. It is generally accepted that business is something wider than a trade but there is no precise definition. It does seem clear that there must be some active involvement by the proprietor.

The letting of furnished holiday accommodation in the UK on a commercial basis can be regarded as a trade for certain CGT purposes. Incorporation relief is not
specified as one of those. Such businesses and property letting businesses generally may, however, qualify on general principles provided that the activities are business activities. It will be a question of fact as to whether the activities are such as to be classed as a business. In the case of Ramsay v R & C Commrs [2013] BTC 1,868, the Upper Tribunal overturned the First-tier Tribunal decision in Ramsay [2012] TC 01871, deciding that a property letting enterprise did constitute a business. The case involved the letting of flats in a large house in Belfast where the taxpayer spent approximately 20 hours per week carrying out various activities, such as meeting tenants, paying electricity bills for communal areas and repairing and maintaining communal areas. In the Upper Tribunal, Mr Roger Berner decided that ‘the proper approach … is to construe ‘business’ broadly, according to its unvarnished ordinary meaning’, rather than relating to meanings given by other tax law such as for IHT business property relief or income tax. The Upper Tribunal considered six criteria, taken from the case of C & E Commrs v Lord Fisher (1981) 1 BVC 392, being:

(1) were the activities a ‘serious undertaking earnestly pursued’;

(2) were the activities a ‘serious occupation’;

(3) whether the activity was an occupation or function actively pursued with reasonable or recognisable continuity;

(4) whether the activity had a certain amount of substance in terms of turnover;

(5) whether the activity was conducted in a regular manner and on sound and recognised business principles; and

(6) whether the activities were of a kind which, subject to differences of detail, are commonly made by those who seek to profit by them,

and also looked at the degree of activity undertaken, to determine whether the property was a business. HMRC’s guidance (CG 65715) now states that ‘you should accept that incorporation relief will be available where an individual spends 20 hours or more a week personally undertaking the sort of activities that are indicative of a business’.

(2) The business must be transferred as a ‘going concern’

The term ‘going concern’ is an unfamiliar one for direct tax purposes, although it is more common in relation to VAT (see In-Depth ¶54-150). In essence, it refers to the
fact that the business is transferred fully operational, so that it could be continued by the transferee without further input and without interruption. HMRC’s Capital Gains Manual CG65710 cites a limitation identified by the court in IR Commrs v Gordon [1991] BTC 130 where, at p. 143, the Lord President observed that: 

‘No doubt a business cannot any longer be described as a going concern if the transferor has taken steps before the date of the transfer to prevent the transferee company from carrying on the business without interruption as it wishes after that date.’

However, earlier in his speech he held that:

‘The phrase with which we are concerned here begins with the word ‘transfers ’. The word is used in its active sense, and it directs attention to what is transferred
to the company on the relevant date by the person who is not a company. The business which he transfers to the company must be transferred to it ‘as a going concern’. The word ‘ as’ is linked to the word ‘transfers’ and this shows that it is the state of the business at the date of the transfer which must be considered.

There is no requirement that the business shall answer to the description of being a going concern at any future date or that it shall continue to be a going concern for
any period after the date of the transfer, nor is the relief said to be affected by what the transferee company may do with the business once it has been received by it. The words ‘going concern’ do not in themselves carry any implication about what may happen in the future or about the length of time which the business must remain in that condition once it has been taken over by the transferee.’

In that case, a farming partnership agreed on 22 June 1983 to transfer its business (including farmland) to a company, the transfer taking effect on 9 September. In the interim, however, an agreement to sell the farmland to a third party was concluded on 23 August, with completion on 28 November. The company was only able to farm that land from 9 September to 28 November, but the transfer was still that of a going concern. (An additional feature of the case was that farming was a business which could be moved from one piece of land to another without being brought to an end.)

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

Assets used in the business would generally follow the business in any transfer, but in some instances, the transferor may wish to retain some assets, often freehold property. The relief, however, requires that all the assets of the business be transferred, with the possible exception of cash (TCGA 1992, s. 162(1)); therefore, the retention of any business asset, other than cash, would be fatal to a claim. This would also include assets that were not shown on the balance sheet (for example, goodwill).

Although ‘cash’ might be said to be limited to that physically held by the business, HMRC accept that the term includes sums held in bank current and deposit accounts (HMRC Capital Gains Manual CG65710). There is, however, no requirement that all liabilities should be transferred to the company and HMRC have confirmed that relief would not be precluded by the fact that some of the liabilities of the business are not taken over and, that if any are taken over, they will not generally amount to consideration for the transfer (ESC D32; see HMRC Capital Gains Manual CG65745 and ¶574-200 ). The concession specifically refers to ‘liabilities of the business’ and does not extend to personal liabilities such as the owner’s tax liabilities

The First-tier Tribunal decision in Paul Roelich [2014] TC03704 , emphasises that for incorporation relief to apply, there must be a ‘business’ (which is something wider that a ‘trade’, but requiring some activity on the part of the proprietor), that business must be a going concern at the point of transfer and all the assets of the business, other than cash, must be transferred. The asset transferred was a contract which provided a stream of income but did not require any activity on the part of the taxpayer. HMRC, quite understandably in the circumstances, did not regard it as a business in itself and as no further assets were apparently transferred, denied relief. The Tribunal however, despite lacking documentary evidence, found that there were other ‘assets’ transferred so that the whole of the assets of the taxpayer’s business had been transferred. (The taxpayer was very fortunate to succeed with this appeal in view of the lack of documentary evidence in support of his claim.)

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

It is important to distinguish between shares issued as consideration for the transfer of the business and those which are issued by way of separate subscription or as consideration for cash left outstanding on a loan account, as, in the latter cases, no relief would be available.

Full relief is given where the whole of the consideration for the transfer is in the form of shares. Where the shares form only part of the consideration, only partial relief is given (TCGA 1992, s. 162(4).  As the relief is only available in relation to consideration in the form of shares, there is no possibility of a gain being rolled over into the cost of QCBs (that are exempt from capital gains tax).  It may however be possible to adjust the composition of the consideration to leave a chargeable gain sufficient to be covered by the annual exemption or brought-forward allowable losses.

Such shares as are included in the consideration are referred to as ‘the new assets’ (TCGA 1992, s. 162(1)).

If part of the consideration consists of a credit balance on loan or current account due by the company to the transferor, that is considered by HMRC to be effectively cash consideration and therefore some restriction of relief will be due (Capital Gains Manual CG65720).

There are no requirements as to the percentage shareholding in the transferee company that the transferor should have after the transfer, nor to the involvement of the former proprietor thereafter.

HMRC also recognise that it may not always be possible for shares to be issued at the time the business is transferred to the company (for example, if the authorised share capital has to be increased first). There is no time limit for the issue of shares but HMRC would expect it to take place promptly after the reason for the delay had
disappeared (CG 65720).

This is intended as an aid and cannot be expected to replace specific professional advice and judgment. No liability for errors or omissions will be accepted. It is the responsibility of those using the information to ensure it complies with the law at the time of use and that it is used in line with relevant rules and regulations governing the subject matter in question. 

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