OTS puts disincorporation relief in spotlight

The Office of Tax Simplification (OTS) is seeking views on future of disincorporation relief, which has only been taken up by a handful of companies since its introduction, and is due to fall by the wayside next year without further action

Disincorporation relief was introduced in Budget and applies to business transfers within the period of five years beginning on 1 April 2013 and ending on the ‘sunset date’ of 31 March 2018.

Its aim was to remove some of the potential tax barriers to a business changing its legal status from that of a limited company and to enable those conducting the business to become, or revert to being, self-employed or in partnership.

On a disincorporation, there are potentially two tax charges. The first is corporation tax on the company in relation to chargeable gains on the market value of its chargeable assets, essentially pre- 2002 goodwill and land/buildings, and any gains on post-2002 goodwill, which are taxed as income. The second is personal tax (normally capital gains tax) on the shareholders when the company’s assets are distributed to them on liquidation.

The disincorporation relief in FA 2013 allows transfers of interests in land and goodwill to be made at cost or written down value (unless the market value is lower), so that no gain is chargeable on the company. However, the tax charges on the shareholders are unrelieved. The relief is limited to businesses with qualifying assets (goodwill or interests in land) valued at less than £100,000 at the time of the transfer.

Despite the Treasury estimate that around 610,000 companies (approximately 40% of UK companies) would be eligible to access the relief, as of March 2016 fewer than 50 claims have been made.

The OTS says it wants to investigate why the number is so small, suggesting this could be down to a number of factors. They include fewer businesses wanting to disincorporate; lack of awareness; the costs of advice; or the limitations of the relief, given the £100,000 limit and that the charge on the shareholder is not also relieved. 

The agency says it continues to hear anecdotally that there is still an appetite for small companies to disincorporate, especially if the relief were to more fully mirror the reliefs on incorporation, and there are suggestions that the £100,000 limit is quite often an early knock-down barrier to consideration of the relief, particularly where non-purchased goodwill is involved.

It also points out that recent changes to dividend taxation on shareholders reduce the tax advantages from incorporation in cases where all profits are withdrawn. The proposed reduction in the dividend allowance from £5,000 to £2,000 which is to be reintroduced in a Finance Bill after the summer recess, is intended to take effect from April 2018, just as disincorporation relief is due to expire. From this date there may be more small companies finding that the additional administration burden outweighs the tax advantages.

Against this background, the OTS has published a paper to draw attention to the fact that the default position, if no action is taken, is that disincorporation relief will cease to apply from 1 April 2018, and to stimulate debate.

The OTS says it is seeing view on whether there is an untapped appetite for businesses to disincorporate to reduce administrative burdens, or views about the minimum improvements that would be needed for the relief to be effective.

The deadline for comments is 15 September.

The OTS focus paper on disincorporation relief is here.

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