Anti-avoidance rules prevent business asset disposal relief applying on capital gains made from transferring goodwill from an unincorporated business to a company. But it’s still possible to achieve a 10% tax rate. How’s it done?
It’s been almost a decade since the government introduced anti-avoidance rules to block the capital gains tax (CGT) advantage from transferring the goodwill of an unincorporated business to a company. The effect of the rules was to prevent business asset disposal relief (BADR) , known as entrepreneurs’ relief until 2020, from applying. This is how the tax break worked before it was blocked.
Example. Jane started her business in 2009. In 2013 her accountant recommended she transfer her business to a company to minimise future income tax on profits. This also created a one-off opportunity for Jane to extract the value of goodwill, then worth £120,000, from her business at a low tax rate. This was achieved by crediting her director’s loan account (DLA) with the value of the goodwill transferred to the company. Jane had to pay CGT on the transfer at the BADR rate of 10%. After knocking off her CGT exemption it meant Jane paid around £11,000 on £120,000 of income. A very good result. If Jane had transferred her business after the anti-avoidance rules were introduced the CGT rate would have been up to 28% instead of 10%.
10% still possible?
While the tax break using BADR is no longer allowed, a 10% CGT tax rate might still be possible when transferring goodwill to a company. This is because in 2016 the standard CGT rates were reduced from 28% and 18% to 20% and 10% depending on the rate of income tax that applies. As a result, with a little tax planning it might still be possible to extract the value of goodwill at just 10%.
Example - part 1
In March 2024 Ali transferred his business to a company in which he owned all the shares. His company paid him for the goodwill and the gain from this was £90,000. Ali’s business profits for 2023/24 were £55,000. This meant that the whole capital gain, after knocking off his annual exemption (£6,000), is taxable at 20% resulting in a tax bill of just under £17,000.
Example - part 2
Had Ali delayed transferring his business until just after 5 April 2024 he could have lowered his CGT bill by almost £4,500. Ali only has to pay tax on company profits when he draws them, e.g. as salary or dividends. Assuming he draws none, in 2024/25 his CGT bill on the sale of his goodwill would, after knocking off his annual exemption of £3,000, be roughly £12,400 (10% x £50,270 plus 20% x £36,730). As the company paid Ali for the goodwill by crediting his DLA he can draw this, tax and NI free, for the cash he needs to live on without touching company profits.
Tip. Transferring your business, including goodwill, early in a tax year rather than at the end of one and crediting the value to your DLA in the company can be tax efficient. This is achieved by drawing on your DLA in priority to taking dividends from your company. This means you can, depending on the value of the goodwill, achieve a tax rate similar to that before BADR was blocked.
Transfer your business and goodwill at the start of a tax year rather towards the end. Up to £50,270 of the resulting capital gain is taxable at 10%. Credit the value of the goodwill to your director’s loan account and draw on this before taking dividends or salary from your company.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.