Disincorporation Relief Close to Extinction

OTS warning over neglecting relief

Disincorporation relief was introduced as a temporary measure from 1st April 2013 following recommendations by the Office of Tax Simplification (OTS) to remove the tax barriers when the owners of small companies want to transfer the business to a sole trader or partnership.

The relief allows transfers of 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. Tax charges on the shareholders when the company’s assets are distributed to them on liquidation are, however, not relieved.

Only small companies will potentially qualify as the relief is only available if the total market value of the assets at the time of transfer is no more than £100,000.

While a limited company is the preferred status for many contractors (and an obligation for some contracts), there are specific obstacles with this business form, including record-keeping and tax implications.

Little or no interest

It was believed that around 610,000 companies, representing approximately 40% of UK companies, would be eligible to access the relief but, as of March 2016, fewer than 50 claims had been made. The OTS believes there are many reasons for this:

• few businesses wish to disincorporate
• there may be insufficient awareness of the relief
• it is too much trouble, or too costly regarding adviser fees or for other reasons, for businesses to take this step, even if there would be ongoing benefits from doing so
• the relief is too limited, either because the £100,000 limit is too low or the tax charge on the shareholder is not also relieved

The OTS 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. This fits with the suggestion that tax charges on a business should, in principle, be the same as far as is possible, whatever its legal form. Furthermore, as the business grows or contracts, or the circumstances of those running it change, tax should not be a barrier to flexibility in changing its legal form. If this is the case, then why is the relief not being used to any significant extent?

There appears to be a lack of awareness amongst businesses and their advisers of the relief and given the limited take-up, this will, therefore, lead to limited experience of it in practice.

It has also been suggested to the OTS that the relief is too limited and to be effective either both tax charges should be deferred, or one should be eliminated. Specifically, the £100,000 limit is often a barrier to consideration of the relief, particularly where non-purchased goodwill is involved

Who wants to disincorporate?

Research carried out jointly for the OTS and HMRC in 2011 showed that 14% of the companies surveyed would like to disincorporate, in particular, those with turnovers between £20,000 – £30,000. These are likely to be mainly small one-person or family companies, which:

• were not formed to obtain, or do not need limited liability, and
• do not, or no longer, need to be incorporated to satisfy criteria applied by suppliers on certain contracts

Last year, the OTS proposed a potential new registered status for self-employed people, called SEPA (Sole Enterprise with Protected Asset). This trading vehicle would offer liability protection while retaining the simplicity of self-employment. If such an entity were made available, then existing companies wishing to move into it would need access to a disincorporation relief.

Recent changes to dividend taxation which will see the tax-free dividend allowance slashed from £5,000 to £2,000 as from 6th April 2018, will reduce the tax advantages of running a limited company and more small companies may find that the additional administrative burden outweighs the tax advantages. For example, the OTS has calculated that the maximum additional post-tax profit from a limited company, compared to self-employment is £2,802, at a profit level of £60,000. This reduces as profits reduce.

Disincorporation relief is due to cease to be as from 1st April 2018, so the OTS have published a short focus paper titled, ‘Disincorporation relief – what of the future?’ to highlight the fact that is no action is taken, then the relief will disappear, and to stimulate debate.

Those businesses that want to disincorporate to reduce administrative burdens or have suggestions as to how the relief could be tweaked to be effective, need to have their voice heard before it is too late, and the OTS would like to hear from them by 15th September 2017.

If you want to learn more, please get in touch.