Where the owner of an unincorporated business sells it and makes a capital gain they may be entitled to entrepreneurs’ relief (ER). This means they’ll pay capital gains tax (CGT) at just 10% on any gain they make from the sale. Until 4th December 2014 ER was allowed for gains resulting from the sale of all types of goodwill even to a company which the seller wholly or partly owned. This was a well known and used tax break.
Example: Sally began self-employment in 2010. In 2013 her accountant advised her to transfer her business to a company, i.e. incorporate it, to minimise future income tax and extract the value of goodwill as cash at a low tax rate. She transferred all business assets to her newly created company. The goodwill element was valued at £100,000 and her company paid her by crediting her director’s loan account which she could draw free of tax and NI. The only tax cost for Sally was for the capital gain she made from the goodwill. Taking account of ER and her annual exemption Sally paid just £8,900 CGT on the £100,000 she received.
Trap: ER ceased to apply to customer-related goodwill on or after 4th December 2014. Had Sally incorporated her business in, say, 2015 she would have paid 28% CGT on most of the gain made from selling the goodwill.
New lower CGT rates
In April 2016 the government lowered the rates of CGT for most types of gain. The lower rate, which applies if your income and gains together are less than income basic rate band, fell from 18% to 10%. For higher and additional rate taxpayers the CGT rate was reduced from 28% to 20%. The new rates mean that with simple planning the tax-saving goodwill trick is back on the menu.
Example – bad planning: In March 2018 Tom incorporated his business. His company paid him for customer-related goodwill and the gain from this was £70,000. Tom’s business profits for 2017/18 were £55,000. This meant that the whole capital gain, after knocking off his annual exemption (£11,300), was taxable at 20% resulting in a tax bill of just over £11,700.
Example – simple tax planning: Had Tom deferred transferring his business until just after 5th April 2018 he could have reduced his CGT bill to £7,025. It works like this: the transfer was in 2018/19. All the profits for that year arise in the company and aren’t taxable on Tom until he draws them. Assuming he draws none, his CGT bill on the sale of his goodwill is, after knocking off his annual exemption (£11,700), 10% on £46,350 and 20% on the balance of £11,950. As the company paid Tom for the goodwill by crediting his director’s loan account he can drawn on this, tax and NI free, for the cash he needs to live. The tax cost for the £70,000 goodwill payment is nearly 10%.
Tip: Transferring your business at the very start of a tax year, and for the remainder of the year living off the sum paid to you by your company for the business’s goodwill means you can, depending on the amount, achieve a tax rate similar to that before ER was blocked.
For more information, we provide a Business Consultation to ensure our clients benefits from tax planning and accounting matters.
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