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selling off partnership into ltd company question

Customer Question
I wonder if you...

I wonder if you could help me - I'm after some advice on capital gains tax.


Me and my wife were in a partnership until 1st of July last 2012. We then formed a limited company and sold all of the partnership assets to it.


The sale price was made of goodwill, website and also fixed assets and stock  (£31K, £6K, £7.2K, £2.2K respectively). I would like to clarify which parts of the total price can be subject to capital gain and which can be under entrepreneur relief and taxed @10% ?


Also, as we withdraw money from the company I wonder if we can be treating that money as company paying back the sale price, rather than dividends until the full amount will be paid back? If that's possible - will it be from company's profits or will that be a cost to the company and lowering it's tax liability?


 

Submitted: 4 years ago.Category: UK Tax
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9/24/2013
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago
Tony Tax
Tony Tax, Tax Consultant
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Experience: Inc Tax, CGT, Corp Tax, IHT, VAT.
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Hi.

You may not have heard of incorporation relief so you should read the HMRC helpsheet HS276. Basically, you can exchange the business assets apart from cash for shares in your new company effectively deferring any CGT liability until you sell the shares in the company. Incorporation Relief is given by default so if you don't want it to apply, you need to elect for it not to apply by the third 31 January after the end of the tax year in which the exchange of business assets for shares took place.

Since you appear to have sold the business assets for cash as opposed to shares in the new company and that cash is sitting as a notional credit in your directors loan accounts in the company, then incorporation relief won't apply. Provided you and your partnership business meet the qualifying criteria for entrepreneurs' relief to apply as set out in the HMRC helpsheet HS275 , it can be used against the gain on the goodwill and the website though I'm not sure how you would value that. Fixed assets (unless they are buildings) and stock are treated as having been sold at their written down value and cost respectively.

Since the company won't have had the cash to pay you for the business assets at the time of the sale, you can draw funds tax free as and when cash flow allows as you will already have disclosed the gain and paid CGT. However, you might also consider dividends and salary (to use personal allowances) if you have no other income sources and would be basic rate taxpayers in the early years so that the business sale proceeds can be drawn when and if you are higher rate taxpayers.

The sum paid by the company for the goodwill can be amortised (written off and claimed as an expense) over a reasonable period so long as it was created by your partnership business after 1 April 2002 or if it existed before 1 April 2002, it was bought from an unrelated party after 1 April 2002. Take a look here and here for more information on amortisation of goodwill.

I hope this helps but let me know if you have any further questions.

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Customer reply replied 4 years ago
Tony,
Thanks for that.
So are there any special criteria for the ER ? We were just a normal partnership, trading since may 2008.
Valuation of the business was worked out as a yearly profit after deducting £30K as wages. I.e. profit was £61K and we were advised to take off £30K as potential wages and that left £31K as goodwill value. Website was valuated as per average monthly turnover it generates (also taking into the account the time/money spent on developing it), and was valued at £6K. So it made a total of £37K.
With the equipment I'm not quote sure how to do it - the value on the partnership books for depreciation was much higher than the market value at the time. Instead of using the book value I have made a list of all equipment that is worth money and put a market value against it. There are also items that we decided not to bring into the company i.e. digital camera, laptop and similar. Should we be paying extra tax for having those items privately? Let's say we bought a camera for £1.5K six months before changing to ltd.
Can you elaborate a bit more on the goodwill amortization - I guess as it was bought from us, directors we are related party?
Many thanks
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago

The HS275 helpsheet gives you the ER criteria. Basically, most trading businesses that don't have as their main source of income the letting of property qualify. That is something of a generalisation I have to say.

I'm not an expert on business valuation nor do I have access to your books so I cannot comment on your figures.

The easiest way to transfer the equipment is to withdraw it from the partnership at its written down value and introduce it into the limited company at the same value. Your accountant will be able to do that. You should withdraw the equipment you are keeping personally at its market value so there may be a balancing charge in the capital allowances computation. You cannot get more than the net cost of an asset in capital allowances. So, if your camera cost £1,500, its written down value is £750 and it is worth £900, there will be a clawback of £150 in capital allowances in you final partnership tax calculation.

As for the amortisation of goodwill, though you are connected to the partnership and the limited company, provided the original business commenced after 1 April 2002 you can claim amortisation relief which means you can write off the goodwill over a number of years. Take a look under the heading "A typical scenario" here for an example and here for some more information. Unless you can come up with an argument for the tax office to write it off over a shorter period, they will allow you to do so at 4% per annum.

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Customer reply replied 4 years ago
Thanks. So we should ideally have a list of all company assets at the time of incorporation and also their book value. The ones that go across to ltd go at the book value, not market? I think our accountant plans to put the difference between the book value and the value of transferred to ltd as a loss and offset against partnership profits.
So what the amortization means in practice? If we withdraw all of the money owed by ltd company in the first year, only 4% of that can be used as expense of the ltd company? Is it then completely gone from accounts or can it be used again and again until the full amount is used up, regardless of how much actual money is withdrawn?
We do have an accountant but she wanted to put all the sale of the partnership, goodwill, equipment, etc under 20% tax which didn't seem correct to me - that's why I wanted to get second opinion :)
So to summarize my original question -

The sale price was made of goodwill, website and also fixed assets and stock (£31K, £6K, £7.2K, £2.2K respectively). I would like to clarify which parts of the total price can be subject to capital gain and which can be under entrepreneur relief and taxed @10% ?

UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago
I'm not aware that you can offset a loss on fixed assets against profit. All you can claim is capital allowances. The recognised way of transferring fixed assets from one business to another is at their written down value. You are then transferring the remaining capital expenditure from one business to another.

The amortisation is not affected by how much of the disposal proceeds you withdraw and when. Once you have settled on a percentage, its a fixed amount each year. I have no idea why your accountant is looking to tax all the items you mentioned at 20%.

As I said in an earlier post, you can claim ER on the gain made on the sale of the goodwill and on the sale of the website, NOT on fixed assets and stock.
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Customer reply replied 4 years ago
She basically put the difference as 'loss on disposal of fixed assets' and it at £15,778.

So I understand that goodwill + website - we can claim ER.
What about the fixed assets/stock - how should that be taxed?
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago
As I said in my first response, stock is treated as having been sold at cost so there will be no taxable profit on the stock held at the time of the transfer.

There is no tax to pay on the transfer of fixed assets. If they are withdrawn at their written down value then that means the partnership has had all the capital allowances it is entitled to. If they are withdrawn at less than their written down value then that means there will be a balancing allowance in the capital allowances computation for the partnership.

If there is a loss on the disposal of fixed assets, there is nothing that can be done with that and, given that there is a loss, there can be no tax.
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Customer reply replied 4 years ago
But, fixed assets sale - wouldn't that cause personal tax liability for both of us?
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago

How can it if you have made a loss according to your accountant? You get capital allowances on fixed assets which write down the cost to £0 over a number of years.

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Customer reply replied 4 years ago
Tony,
One example is that we have bought a piece of software for £20K. It was not fully written down i.e. £5K left. But the market value of that software is now closer to £700-800. So she put the difference as a loss I believe. And similar with other items.
Can you confirm about the personal tax on the sale of fixed assets, please?
Many thanks
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago
If you sold it to the company for £700 to £800 , you withdraw it from the partnership at £700 to £800 and claim a balancing allowance in your partnership tax return of £4,200 to £4,300 which reduces your taxable profit by a similar amount. That means that each of the partners will pay less tax. The software is then introduced into the limited company at a cost of £700 to £800.
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Customer reply replied 4 years ago
Ok, thanks.
And finally, the assets introduced into the limited company be taxed again? ( I mean on us, personally ?)
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago

Why would they be taxed again? You haven't paid tax on the assets once, let alone a second time.

Let me give you an example:

I buy a piece of equipment for my business for £10,000. I claim capital allowances on it over several years totalling £6,000. That leaves unrelieved expenditure of £4,000. If I dispose of the asset either to a third party or my company for £3,000, my net cost is £7,000 (£10,000 - £3,000). As I have already had capital allowances of £6,000, I am entitled to a balancing allowance (a deduction from my trading profit) of £1,000 (£10,000 - £3,000 - £6,000). You never get more allowances than the net cost of an asset.

 

The buyer of the asset introduces that asset into their business at a cost £3,000 and they can claim capital allowances up to £3,000.

 

If I had sold the asset for £5,000, my net cost is £5,000 (£10,000 - £5,000). I've had allowances of £6,000 so there is a balancing charge (an addition to my trading profit) of £1,000 (£6,000 - £5,000).

If you sell a fixed asset for more than it cost to buy then you may have Capital Gains Tax to pay if your total gains in a tax year exceed £10,900.

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Customer reply replied 4 years ago
Yes, again is not the right word :)
Apart from the tax at our rate (20%) will we also have to pay nic on it?
That's the last question I promise :)
UK Tax Professional: Tony Tax, Tax Consultant replied 4 years ago
If you have balancing charges which increase your taxable profit then you will pay NIC if your respective partnership profit shares are above the point at which Class 4 NIC starts.

A balancing charge is simply a clawback of capital allowances you are no longer entitled to. When you had those allowances originally, you would have paid less tax and NIC.
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