Election to disapply incorporation relief

Where you transfer your sole trader or partnership business to a company in which you own shares, often referred to as incorporating your business, it counts for capital gains tax purposes as if you had sold it. However, tax rules automatically apply so-called incorporation relief to prevent any capital gains tax charge. This might not be tax efficient.

When can you use the election?

Where incorporation relief applies to prevent taxation of a capital gain resulting from the transfer of an unincorporated business to a company you can elect for the relief not to apply.

Deferral might not be advantageous and so it is possible to elect for the gain not to be deferred.

Example. John started a sole trader business from scratch and after three years transferred it to a company. The value of the business’s goodwill was £11,000. As he paid nothing for it the taxable gain resulting from the transfer is the whole £11,000. However this would automatically be deferred meaning that when he sold his shares in his company the £11,000 gain would be added to any gain resulting from the rise in value of the shares. If John elected for the £11,000 not to be deferred it would have been taxable but covered by his exemption. When he sold his shares the £11,000 gain wouldn’t be added because it would have already been taxed even though the tax bill was zero. 

How to make the election

The election can be made in a letter or included in the additional information space of your self-assessment tax return. It must reach HMRC by no later than the 31 January which is two years later the normal filing date for the tax return covering the year in which incorporation of the business occurred, e.g. an election in respect of a transfer made in 2022/23 must be made by 31 January 2026.

The election deadline is shortened by a year where you sell your shares in the year following that in which your business was incorporated.